Market sentiment shifts! Hedging against Japanese election risks heats up, with trading volume of bearish yen options doubling

According to the Zhitong Finance APP, options traders are changing their positions on the yen's trend, with some investors betting that political turmoil in Japan, escalating trade frictions, and shifts in Federal Reserve policy expectations will drive the yen's depreciation against the dollar. Data from the Central Limit Order Book of the Chicago Mercantile Exchange Group shows that on July 11, the trading volume of bullish options (which increase in value when the yen depreciates) for USD/JPY reached more than twice that of bearish options.

Graham Smallshaw, a senior forex spot trader at Nomura Singapore Limited, stated, "The market is interested in low-priced bullish structures for one-month periods, which can cover risks during the Japanese elections—besides the ongoing uncertainty of US-Japan tariff negotiations, the elections may trigger more volatility."

This options positioning contrasts with previous data from the Commodity Futures Trading Commission (CFTC): as of July 8, asset management institutions held a net long position of 89,331 contracts for USD/JPY, indicating a previously bullish sentiment towards the yen.

Smallshaw added that some traders are targeting a rebound of USD/JPY towards the 200-day moving average (currently at 149.71). The currency pair closed last week at 147.43. Current popular trading strategies include buying call options with knockout clauses (such as reverse knockout call options), which are more cost-effective than standard call options, as they automatically expire if the exchange rate breaches specific barrier levels.

Market expectations suggest that the election results may pave the way for further fiscal stimulus, which has already pushed Japanese long-term government bond yields higher. HSBC strategists Paul McCall and Zhou Qiao noted in a client report on July 10 that USD/JPY currently shows a positive correlation with the 30-year Japanese government bond yield and the steepening of the yield curve.

Taro Kimura, a senior Japanese economist at Bloomberg Economics, stated, "If the market begins to believe that Shigeru Ishiba may step down after the election and starts pricing in a shift towards fiscal expansion, Japanese interest rates may rise further."

Akira Hoshino, head of Citigroup's Japan markets division, said, "On the eve of the Japanese Senate elections, we see some funds increasing their long positions in USD/JPY," adding, "In all yen currency pair trades, the market expects the yen to weaken due to the potential impact of the election results."

McCall and Zhou also warned that the lack of progress in US-Japan trade negotiations, combined with fiscal concerns, is "undermining market confidence in the yen." Last week, US President Trump announced a comprehensive 25% tariff on Japanese goods starting August 1, citing the need to eliminate the trade deficit between the two countries.

The latest US non-farm payroll report further stimulated bullish trading interest in USD/JPY. Smallshaw remarked, "The report seems to have led the market to reassess the timing of the US economic slowdown, delaying expectations for a Federal Reserve rate cut, thereby triggering interest in summer arbitrage trading." Arbitrage trading typically refers to borrowing low-interest currencies like the yen and investing in high-interest currencies like the dollar to capture the interest rate differential