Dollar-yen options suggest traders are underestimating event risks

Dollar-yen options show traders may be underestimating the downside potential near term and the prospects of heightened risk-aversion. All that may change with the spate of key global events in coming days.One-month risk reversals in the spot is still relatively cheap compared to levels seen last month during Italy’s political crisis. This suggests limited demand to protect against declines in dollar-yen. Yet, over the next seven days, the US will face off its trading partners at the Group-of- Seven summit, President Donald Trump is due to meet North Korea’s Kim Jong-un and the central banks of America, Europe and Japan will decide on monetary policies.The yen’s status as a haven currency means the dollar-yen’s bullish start to June could quickly reverse amid these event risks. During the recent rout triggered by Italy, one-month dollar-yen risk reversals more than doubled to 1.28 - with puts favoured over calls - in just over a week. Compared to that, Friday’s level of 0.87 makes traders appear a bit complacent.Technically, the spot pair has breached initial resistance around 110.00, but failure to push through resistance at 111.40, May 21 high, could result in a bearish head-and-shoulders formation. This may lead to a test of 108.00, with a decline to 106 not improbable. Options traders will watch this closely.A global trade spat still looms and the only real winner in event of further tit-for-tat tariffs will be the yen.Next is the historic Trump-Kim summit on June 12. Anticipation of the event has gripped financial markets for weeks. The highly unpredictable meeting means traders may be more sensitive to negative headlines than positive ones, to the yen’s benefit.As for the monetary policy meetings, a Fed rate hike this week is largely expected by the market. Likewise, expectations for the BoJ to remain on hold. As such, the divergent monetary policy theme will focus on the central banks’ signals. If the Fed adopts a sanguine tone and keeps its 2018 rate hike projection to three, it may well be the yen that rallies.Finally, the turmoil in Italy is far from over even with the populist government in power. Italian 10-year yield is already back above 3%, and if its ascent accelerates, the rout in global risk assets last month may be just the preview.