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USD/JPY option pricing is throwing up an anomaly that suggests the market is bracing for official intervention rather than simply pricing in further JPY weakness.
Risk reversals are a classic directional volatility play as they capture the difference in implied volatility, and therefore the premium, between puts and calls on the same underlying.
For USD/JPY, that means the relative cost of JPY calls (the right to buy JPY, i.e., USD/JPY downside) versus JPY puts (the right to sell JPY, i.e., USD/JPY topside).
Normally, risk reversals simply track spot. A good recent example is EUR/USD post-Fed, where slow, grinding EUR/USD weakness fed straight through into downside skew. 1-month 25-delta risk reversals widened from an initial 0.1 to 0.35 EUR puts over calls, with implied vols firming too, but with no panic bid for deeper protection given the move is gradual, not disorderly.
USD/JPY should be behaving the same way. The pair is grinding higher and looks vulnerable to further gains after last week's Bank of Japan hike came in less hawkish than hoped, a disappointment now compounded by broad USD strength. Logic says risk reversals should tilt to reflect that topside vulnerability and result in richer JPY puts, cheaper JPY calls.
Instead, the opposite is happening. Benchmark 1-month 25-delta risk reversals have seen their JPY call premium over JPY puts widen from 1.9 vols to 2.3 vols since the BoJ decision, even as USD/JPY has risen over 200 pips in the same window. Spot and skew are pulling in opposite directions, indicating that something other than pure directional flow is driving pricing.
This divergence points to growing market unease over potential official intervention to cap further JPY weakness. Rate checks were already spotted immediately after the BoJ decision, helping to partially reverse the rapid USD/JPY spike from 156.00 to 158.06. Yet the pair has already clawed back into the high 157s, keeping intervention risk squarely in play.
The takeaway from all this?
Those holding JPY calls stand to benefit disproportionately
from any fresh rate checks or actual intervention that
strengthens JPY, which is precisely why demand, and the premium,
for those options remains elevated even as spot pushes the other
way.
USD/JPY 25 delta risk reversals
(Richard Pace is a Reuters market analyst. The views expressed are his own; Editing by Alexander Smith)
