Put options are no longer the preferred choice! US and Japanese forex traders are beginning to change their strategies.

Notice that, with President Trump's inauguration now over, USD/JPY options traders are changing their strategies to deal with the expected rate hike by the Bank of Japan on Friday. Prior to this week, as expectations of a rate hike by the Bank of Japan increased, investors' preference had been to buy put options, as the value of these options would rise if USD/JPY continued to decline. Now, this expectation is mostly priced in, and investors are turning their focus to a strategy that would benefit if the currency pair experiences narrow fluctuations after the policy decision. The implied volatility of USD/JPY has been under pressure in the past few days. On Thursday, this indicator fell for the sixth consecutive day to its lowest level since July. Graham Smallshaw, Senior FX spot trader at Nomura Singapore Limited, said: "Volatility selling has been a theme since the inauguration as uncertainty surrounding Trump's tariff threats intensifies." Smallshaw added: "Prior to the inauguration, clients were mainly focused on downside crosses in the options space in both USD/JPY and the direct JPY crosses, mainly to hedge potential risk on equity trades made in anticipation of Trump's possible tariff imposition." He noted that this strategy aligns with the increasing belief that the Bank of Japan will hike rates this week. Meanwhile, the premium for hedging against a drop in USD/JPY in the next month has decreased relative to the premium for hedging against a rise, indicating reduced short-term interest in further declines for the currency pair. Forward pricing suggests that a 25 basis point rate hike by the Bank of Japan is almost certain after last week's hawkish comments. Considering this, the downward momentum of USD/JPY has stalled. So far this week, USD/JPY has not been able to break below support near the 50-day moving average. Dovish rate hike This means that investors expecting further declines in USD/JPY due to the rate hike may ultimately be disappointed. Christopher Wong, FX strategist at OCBC Bank in Singapore, wrote in a client report this week: "From the market's perspective, the risk is in a dovish rate hike as this may mean that the downside in USD/JPY could be more limited." With expectations of a second rate hike later this year already largely priced in, a dovish rate hike could make the currency pair more susceptible to appreciation. Some funds are exploring this possibility. One indication of this is the limited demand for European-style knock-out options (ERKO), which cease to exist once triggered at a certain price level, and can only occur at the option's expiry. Smallshaw mentioned, "With the impact of this week's Bank of Japan rate hike mostly priced in, there has been some interest in the cheap USD/JPY ERKO structures, but the interest remains limited."