Investors Should Sell Yen Calls on Portfolio Outflows, RBS Says

By Stanley White and Hiroko Komiya

July 23 (Bloomberg) -- Investors should enter three-year risk reversals by selling yen call options and buying yen puts versus the dollar as Japanese investors may increase purchases of overseas assets, said Royal Bank of Scotland Group Plc.

The three-year risk reversal rate is showing an excessive premium for yen calls, which grant the right to buy, over puts that allow sales, Britain's second-biggest bank said.

Japanese portfolio outflows may rise to about 12.5 trillion yen ($116.5 billion) in 2011 from their current annual pace of 11 trillion yen, RBS said, citing models based on the s-curve used to show the adoption of new trends. Japan's benchmark rate of 0.5 percent is the lowest among major economies, increasing the appeal of higher-yielding assets overseas.

``After next year, the yen is more likely to weaken to 110 than it is to rise to 90,'' said Masafumi Yamamoto, head of foreign exchange strategy for Japan at RBS in Tokyo, confirming a report he wrote yesterday with Nhan Le and John Richards. ``Investor outflows and have picked up pace and will continue. The market will correct its bias for yen calls.''

The yen was little changed at 107.23 per dollar at 2:19 p.m. in Tokyo. It declined yesterday to a two-week low of 107.45.

The three-year 25-delta risk reversal rate narrowed to minus 5.11 percent from minus 5.18 percent yesterday. A negative rate shows traders place a greater premium on yen calls. Delta measures the rate of change in an option's value relative to currency moves.

Risk Reversals

Investors should sell a yen call with a strike price 10 percent below the dollar-yen's three-year forward rate, according to Yamamoto. Investors should also buy a yen put with a strike price 10 percent above the forward rate, he said.

A strike is the price an option holder may buy or sell a currency. Forward rates adjust for interest-rate differentials.

Japanese households hold 1,500 trillion yen in assets, more than the combined household assets in the U.K., France and Germany, the report said. Overseas investments comprise 4 percent of Japanese household assets, and growth in portfolio outflows may not reach its peak until 2018, the report said.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net; Hiroko Komiya in Tokyo at hirokokomiya1@bloomberg.net