Dollar Volatility Rises to Six-Month High After Lehman, Merrill

By Stanley White

Sept. 16 (Bloomberg) -- Volatility implied by dollar-yen options expiring in one month rose to the highest in six months after Lehman Brothers Holdings Inc. filed for bankruptcy and Bank of America Corp. agreed to acquire Merrill Lynch & Co.

Traders bought options known as straddles to hedge against declines in the dollar on speculation credit-market losses will prompt a reduction in so-called carry trades, said Takeharu Miki, currency options manager at Bank of Tokyo-Mitsubishi UFJ Ltd. The premium for dollar put options that grant the right to sell over call options that allow purchases widened to the most in two months, showing more risk of weakness in the U.S. currency.

``People are in a panic to buy volatility,'' said Miki of Bank of Tokyo-Mitsubishi UFJ, a unit of Japan's biggest publicly listed lender by assets. ``News on Lehman and Merrill is pretty bearish for the dollar and bullish for the yen. I've been in the market for 15 years and I've never seen a counterparty the size of Lehman completely disappear.''

The dollar fell to 104.04 yen, the lowest since July 16, and traded at 104.39 yen at 12:47 p.m. in Tokyo from 104.66 late yesterday in New York and 107.94 at the end of last week.

In carry trades investors borrow in countries with low interest rates and buy higher-yielding assets elsewhere. The risk is that currency market moves erase those profits. Japan's 0.5 percent benchmark rate compares with 2 percent in the U.S.

Implied volatility for one-month dollar-yen options rose to 17.86 percent, the highest since March 19, and was last quoted at 17.61 percent from 17.24 percent late yesterday. Volatility may rise to 20 percent should the dollar approach 100 yen, Miki said.

The one-month 25-delta risk reversal rate widened to minus 4.07 percent, the largest premium on dollar puts over calls since July 16. Delta measures the rate of change in an option's value relative to moves in the underlying currency.

`Caught Out'

Traders bought one-month straddles, call and put options with the same strike price and duration, for a volatility of 18.3 percent, Miki said. Holders of straddles benefit from large moves in the underlying currencies. Dealers quote implied volatility, a measure of expectations for future price swings, as part of pricing options.

Traders also entered three-month risk reversals by selling dollar calls and buying puts at a 4.7 percent premium, he said.

``People in the interbank market who were short in dollar puts got caught out,'' Miki said. ``The dollar is down three yen from the end of last week, and that's quite a surprise.''

Lehman, a 158-year-old firm, filed for the biggest bankruptcy in history yesterday after Bank of America and Barclays Plc pulled out of talks to buy the New York-based bank. Bank of America, the biggest U.S. consumer bank, instead agreed to acquire Merrill Lynch for about $50 billion, as losses on difficult-to-value securities tied to mortgages claimed another of America's oldest financial companies.

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