FX Options Lowdown: Has anyone seen any one-month yen?

• There's an interesting correlation between the Shanghai Composite and USDJPY

• USDJPY spot volatility has caused movements in the currency options market

• The first BoJ meeting of 2016 may see a continuation of its cautious approach

• Even with some BoJ easing, yen strength may be inevitable

A look at the correlation between the Shanghai Composite Index and the spot USDJPY price shows a close trend (see below). The yen has traded in a 10 big-figure range between 115.86 and 125.86 against the greenback for over a year now, and currently stands at approximately 118.0. The similar movement between the two lines on the graph below are evident of the investment into JPY that occurs in a risk-off environment.

China's economic woes have been the most prominent theme of 2016 so far, and ensured that the market began in ugly fashion on January 4. Of course, evidence of this safe-haven buying is not new, this has been a characteristic of the currency for many years indeed. Yet the relation between mainland Chinese equities and such trading is more pronounced now than ever before, as the slowdown in growth within the Red Dragon is more apparent than ever before.

There seems to be more conviction here than there was last year too. On August 24, 2015, USDJPY moved from 120.20 to 116.18 in a matter of minutes after the Shanghai Composite lost 8.5%. Close to £74 billion was wiped from the FTSE 100 Index as a result. The USDJPY move was intense, and was likely to be a result of large position unwinding.

This year, the move seems more market-wide, so to speak. There will be bounces, as seen during Asia Pacific trading on Tuesday January 12, but a move lower seemed to involve leveraged names across the board, as well as other such investors. Positioning within the inter-bank spot market regarding JPY is net long for the first time since 2012.

USDJPY was trading at around the 80.0 mark at the time, before Prime Minister Shinzo Abe introduced economic reforms. Support levels of 116.18, 115.86 and 115.58 can be linked to market catastrophes in the recent past. The former is the aformentioned low of August 24 last year.

The middle figure of 115.86 is is that reached on January 15 this year, in response to Swiss National Bank action and is the bottom end of the 10 big-figure range. Lastly, the 115.58 level was that which the pair reached in December 2014, in response to drastic movements in Russian rouble caused by oil price fluctuations.

USDJPY spot volatility has caused inevitable movements within the currency options market. A look at both the one month straddle and 25-delta risk reversal structures shows that both volatility and interest in downside strikes has increased, despite the recent squeeze over the last 48 hours.

If over the medium to long term this year the USDJPY continues to feel pressure, the demand for JPY call options is likely to increase further, and volatility with that.

A look at the volatility in those options within the JPY cross space tells a similar story. Amid Chinese economic concerns, demand for raw materials has suffered greatly. Both copper and iron ore future prices are close to all-time lows at $200.20 and 282.50 yuan respectively.

This, in turn, has affected those currencies that export those and other similar raw materials such as the Australian, New Zealand and Canadian currencies. AUDUSD one month straddle volatility has risen from 10.5% to trade as high as 13.5% this year in itself.

If you twin the Aussie dollar with the yen, as in the graph below, it is evident that volatility has moved through the roof. The graph shows AUDJPY volatility in comparison to the yellow line of EURJPY volatility. EURJPY is a popular pair that is also subject to potentially choppy markets, but it is the volatility in the AUDJPY cross that has risen so much more significantly.

The first meeting of 2016 for The Bank of Japan on January 29 may well see a continuation of the pensive and cautious approach evident from the central bank recently. Governor Haruhiko Kuroda mentioned last week that he expects the country to achieve the 2% inflation target with a maintenance of current fiscal policy, and this includes quantitative and qualitative easing.

Whether achieving this goal is actually possible is another article in itself, but the current sentiment suggests that no major changes will take place later this month. China's woes may subside here and there in the short term, but ultimately may be expected to persist throughout the year.

Therefore without BoJ intervention, and even with some easing, JPY strength may be inevitable. Breaking through 115.0 could be a distinct possibility, whilst upside Ichimoku resistance lies at approximately 120.70. The rise in JPY call option demand and JPY related volatility in general would then be foreseeable, and this would be most evident in a pair such as USDJPY, let alone such crosses as AUDJPY and CADJPY.