26 October 2011 at 16:51 GMT
In spite of USDJPY printing fresh all-time lows, the options market is still paying for low delta front-end upside options. Indeed we are seeing continuous demand for USD call / JPY puts with strike around 78-80. Clearly this is an unusual situation, as front-end volatilities and risk-reversal tend to follow spot movements. The big unknown there is, of course, possible Bank of Japan intervention: fear of such intervention is generating demand for JPY puts. Japanese officials have certainly been vocal about it, but decisive action still needs to be taken.
It seems that the demand for upside is driven by client flows which float into the interbank market. However, spot is still hovering just above the lows, despite this fear of intervention. It could be argued that spot should already be higher if market sentiment was pricing a very high likelihood of intervention (in EURCHF for instance the Swiss National Bank is seen as actively protecting 1.2000, and spot players are positioning themselves ahead of this level). Options then become the preferred vehicle to express an intervention play as they provide a limited downside if nothing materialises.
It is also important to note that this demand for upside strikes is mostly focused on the front end of the curve. The mid to back end still favours USD puts / JPY calls as the options market remains heavily exposed to higher volatilities should spot head south.
Whilst the reasons why the BOJ should intervene are regularly being discussed, it is also important to remember that there are normally at least two sides to a story. For instance, most Japanese producers are heavily dependent on raw materials and commodities priced in USD. Moreover, the US is just one of Japan's main trading partners.
EURJPY is not quite at the lows seen earlier (it was sub 90.00 in 2000); China and other Asian economies are also not seeing their currencies weaken too much against the JPY. So whilst the world is looking at where USDJPY is trading, to find out if the BOJ is getting ready to pull the trigger, Japanese officials are probably looking at many other factors like the price of oil and the level of CNY and KRW vs. JPY.