Premium on currency options dips

The premium demanded on currency options from developing economies fell from a seven-month high as signs of faster economic growth lifted demand for risky assets.

The spread between volatility on currency options from developing and major economies had declined by more than half in the last two weeks, according to data compiled by JPMorgan Chase & Co.

The spread touched the widest since November on June 21, as the collapse of two Bear Stearns Companies hedge funds invested in subprime mortgages caused an exit out of risky assets.

Premiums narrowed last week after a government report showed US employers last month added more jobs than expected in June. The jobs data suggested that the US economy is accelerating from a first-quarter slowdown and fuelled speculation that robust global growth would help buoy emerging economies.

"People are quite happy again to put on more risk and invest in emerging markets,'' said Marcel Neeleman, emerging market options trader at BNP Paribas in London. "People were worried that housing might have an effect on growth and the global economy.''

The JPMorgan three-month implied volatility index tracks swings in the Mexican peso, South Korean won, Brazilian real, Polish zloty, Singapore and Taiwan dollars, and South African rand.

The bank's index on major currencies includes the Swiss franc, the U.K. pound, the euro, the Japanese yen and the Canadian and Australian dollars.

Options prices show traders expect emerging-market currencies to fluctuate an annualised 6.57 percent, down from a peak rate of 12.2 percent from data going back through 2000, when New York-based JPMorgan began tracking the data. This so-called implied volatility is 0.50 percentage point above the 6.07 per cent rate on the bank's index on major currencies.

"The market has digested the Bear Sterns hedge fund news and realised that the problems in the subprime market aren't likely to spread broadly'' hurting other market sectors, said Tim Owens, head of currency and structured products at JPMorgan in London.

The US labour department reported on July 6 that employers added 132,000 workers in June, exceeding economist estimates, for a 125,000 increase.

The Morgan Stanley Capital International index of emerging-market stocks hit a record high on July 9 at 1120.28, an increase of 23 percent this year. The Dow Jones Industrial Average has gained 9.2 per cent this year to 13,611.68.

"The spread between emerging market and major currency option volatility should narrow further falling back into the previous pattern'' that held since last year, said Owens.

In March, the rate on the bank's developing nation volatility index fell below that on the index on major currencies. The premium was as wide as 2.6 percentage points in June 2006.

Increased confidence in the developing nation central banks' ability to fight inflation and damp currency swing through intervention helped reduce implied volatility on emerging currency options, said Owens.

The inflation rate in developing nations fell to 5.3 per cent in 2006 from 6.7 percent in 2001, IMF data show. In Brazil, the rate fell to 3.69 per cent in the 12 months through June, from a record 6,821 per cent in 1990.

Brazil's currency has gained about 12 per cent, the best performer among the most-actively traded currencies against the dollar this year.

Developing countries are benefiting from higher prices of commodities from copper to oil, increasing government revenue from exports. Crude oil prices have risen 19 per cent this year, and gold prices have more than doubled in the last five years.