ANALYSIS-FX options market embraces weak U.S. dollar view

among options investors, mirroring the prevailing weak stance on the currency in the spot market.

Short- to long-term maturities in euro risk reversals have favored euro calls and dollar puts -- three-month and one-year

A positive risk reversal means the volatility of call options exceeds the volatility of similar put options, implying

"Dollar puts are in demand, suggesting expectations of dollar weakness. That, in turn, is embedded in a global recovery,"

said Andrew Wilkinson, options analyst at Interactive Brokers Group in Greenwich, Connecticut.

"Dollar weakness could have some way to run at least in terms of the mindset of investors."

Expectations for the dollar's fall after last year's strong gains gathered momentum after signs that economies around the

Japan, Germany and France have all posted positive growth in second-quarter gross domestic product. Even the United

States, where the credit storm started two years ago, seems on a path to recovery.

STOCKS RALLY WORLDWIDE

This news sparked stock market rallies around the world and a dollar sell-off. The S&P 500 is up 13.6 percent so far in

2009, while the ICE Futures dollar index, a measure of the greenback's value against six major currencies, is down 3.8

percent this year after a 2008 gain of nearly 6 percent.

Investors bought the dollar amid the worsening global financial crisis last year and sold currencies such as the euro and

sterling as their economies sputtered.

But a more positive euro outlook has become more evident in recent sessions after the upbeat GDP readings in Germany and

"There is an underappreciated story that Europe is recovering faster than we thought," said Richard Franulovich, senior

currency strategist at Westpac in New York. "I think the euro story has further to run, which should argue for the euro

touching $1.45 to $1.46."

In contrast, the Federal Reserve's commitment to keeping rates "exceptionally low ... for an extended period" suggests

That doesn't mean, however, that the options market is less bullish on the Aussie than the greenback. Traders said the

decline in Aussie risk reversals occurred as the Aussie dollar topped near US$0.85 a few weeks ago. Many fear the Aussie

is overvalued, and this caused a scramble for Aussie puts as downside protection against long positions in the currency

DECLINING VOLS

measure how much investors expect a currency to move in either direction in a given time.

Declining volatility suggests the worst of the financial crisis may have passed and investors are once again comfortable

taking risky bets. Vols across all asset classes soared last year as the credit crisis hit financial markets, resulting

in investment bank Lehman Brothers' collapse and insurer AIG's bailout by the U.S. government.

On Monday, vols of one-month euro/dollar options were at 10.55, declining from highs of 15.95 in June and 23.60 in

January. Similar yen vols are at 13.05, down 21.7 percent since the year began.

slid more than yen and euro vols, falling 72 percent since the peak last October.

Analysts say options on dollar/yen and some of the yen crosses have become expensive relative to the VIX, which suggests

Simon Smollet, FX options strategist at Calyon in London, said there is no sense for "yen cross activity to be

significantly above that of the S&P 500."