Hedge Funds Are Using Options to Bet on Year-End Dollar Gain

(Bloomberg) -- Hedge funds worldwide look to be favoring the dollar in the option market as they bet that the currency’s rebound versus most major peers will extend into year-end.

Funds in Europe and Asia have ramped up option trades this week based on the view that currencies, such as the euro and yen, will weaken against the dollar, according to traders. Euro-dollar put options expiring by December, which gain in value if the currency pair falls, saw three times more trading volumes than call options on Wednesday, data from the Chicago Mercantile Exchange Group show.

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“We have seen hedge funds looking for a tactical play in long dollars in the short term,” said Mukund Daga, global head of currency options at Barclays Bank Plc. referring to expiries before year-end.

Rising wagers favoring the dollar in the option market may be a sign that weakness in the currency spurred by the US government shutdown may have run its course as other major peers drop. The euro has been pummeled by France’s political turmoil, the yen slumped on speculation Japan’s likely new leader may favor slower interest-rate hikes, while the New Zealand dollar was hit by a 50-basis-point rate cut.

Hedge funds expressed a bullish view on the dollar against most Group-of-10 currencies, with the exception of the Australian dollar due to a hawkish Reserve Bank, Daga said. They bought vanilla call options or call spreads against the euro, sterling, yen, and the New Zealand dollar.

A vanilla dollar call option is a standard contract without any complex features, which increases in value if the greenback rises. A call spread caps the potential for profit should the dollar rally.

“Most of the dollar call buying has been in the G-10 majors and the jumps in front-end risk reversals in these currencies are a good indicator of the turn in demand,” said Nathan Swami, Singapore-based head of FX trading for Asia Pacific at Citigroup Inc. A risk reversal compares the price of a call option versus that of a put option.

According to Swami it’s “still too early to tell if this is a definite sign that the dollar has bottomed out.” However, Daga said he has seen tactical buying of longer-term cheaper options that profit from a significant dollar rally, often referred to by traders as a “tail risk.”

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The Bloomberg Dollar Spot Index slipped 0.2% in Asian trading on Thursday, but it remained near the highest level since early August.

“The overarching theme is that the confidence in fiat currencies is extremely low, but among the fiat dollars are still a better hold,” Daga said.

(Updates with location of the hedge funds in paragraph 2.)

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