Yen / Dollar -- Option Opportunity ~ Steve Blitz Morning Notes
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Wednesday, July 8, 2009

Yen / Dollar -- Option Opportunity

On April 24 I wrote a post on the technical outlook for the Yen/Dollar exchange rate.

The $/Yen chart and momentum indicators suggest that the dollar bounce against the yen is ending if not over -- no guarantees as you know and any bets you make are your own responsibility. The dollar should broach the lows set in the mid 1990s but the ultimate downside is as yet indeterminate. Because the forwards are pretty flat relative to spot, thanks to effective zero interest rates in both the U.S. and Japan the spot and the forward are pretty close making it less expensive to bet on a dollar decline than it used to be. To see Yen rally past 80 by September might be a fundamental shock to some (not me) but not a technical one.
Nothing's changed except that the breakdown is beginning. More important than a point forecast is that similar low interest rates here and there puts the forwards where spot is rather than where one would expect it to be. The chart below, courtesy of Bloomberg, shows the forward curve today and the change in the past month. Right now spot Yen is 92.71 and one year forward is 92.32. A month ago the one year forward was 96.56.

At-the-money options are priced to the forward so a one year yen call versus the dollar struck well out of the money will be relatively cheap relative to expectations -- even though high implied volatility has likely given some of the bargain back to the option seller. Nevertheless, betting on 85 in one year's time has a good risk/reward ratio, in my opinion. Of course, no guarantees, you are on your own, and this trade is not suitable for everyone -- only you can figure that one out.

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