Some traders are failing to profit from the biggest plunge in Japan's currency in almost two decades after underestimating the speed and degree of the decline, rendering even bearish yen-option bets worthless.
The yen has weakened 17 per cent against the US dollar since the start of the fourth quarter and reached the lowest level since May 2010 on February 11, marking its worst performance over a similar period since 1985. Strategists and some option traders failed to anticipate the extent and the velocity of the move.
Prime Minister Shinzo Abe's efforts to end deflation and spur economic growth caught the currency market by surprise. Traders anticipating a weaker yen bought so-called reverse knock-out options, which are used to profit from price moves towards a specific level. The options expired worthless after breaching the target ceiling price as the yen slipped faster than expected. By trying to save on the premium paid on a regular option, buyers of the knock-outs ended up missing out on the large price swing.
"Not many people have been involved in this entire move," said David Woo, head of global rates and currencies research at Bank of America-Merrill Lynch in New York. "A lot of it was in the form of options, which got knocked out. Despite the magnitude of the move, it seems that nobody has enough of a position on."
Traders whose holdings were wiped out by the drop in the yen would buy more options with higher target prices, Woo said. Those purchases are serving to push the yen lower.
Strategists were also caught out. At the start of the decline, when the yen was 77.96 per dollar on September 28, they predicted a 2.6 per cent drop to 80 by the end of the first quarter. That forecast fell to 85 by January 14. The yen slid 0.1 per cent to 93.48 in Tokyo morning trade yesterday, snapping a two-day rally. It weakened for 12 consecutive weeks before rising 0.1 per cent for the five days to February 8.
Group of Seven nations this week avoided directly criticising Japan for introducing measures to weaken its currency, reinforcing speculation that they will let yen debasement continue. The Bank of Japan said last month that it would conduct open-ended asset purchases from January next year, buying 13 trillion yen (HK$1.08 trillion) in assets a month and setting a 2 per cent inflation target.