Hong Kong Dollar Options Suggest Peg Is Most at Risk in a Decade

Options traders are betting the Hong Kong dollar’s peg is the most vulnerable it’s been in a decade as China’s shift to a freer exchange rate prompts speculation the city’s link will come under pressure.

The currency’s one-year implied volatility, a gauge of expected price swings used to price options, has more than tripled to 3.2 percent since a surprise yuan devaluation on Aug. 11. That’s near the yuan’s reading on the day before it was weakened in a move that ended China’s de facto peg of more than four months. Hong Kong’s currency has been kept at about HK$7.80 per U.S. dollar since 1983.

The People’s Bank of China devalued the yuan and switched to a more market-oriented exchange rate, sending the currency into its steepest slide in two decades. That spurred exchange-rate shifts in Kazakhstan and Vietnam, and made investors nervous about regime changes in other currencies including the Hong Kong dollar, according to Barclays Plc.

“The surge in volatility is understandable, with what other central banks have done and hence some speculation on the fate of the Hong Kong dollar peg,” said Mole Hau, an economist at BNP Paribas SA. “But the Hong Kong Monetary Authority is not going to change the peg as we see little alternative. As history repeatedly shows, the authorities are willing to absorb substantial short-term pain to hold the peg.”

No Intention

The peg continues to serve Hong Kong well, and there is no need or intention to change the system, an HKMA spokesperson wrote in an e-mail. The authority will continue to monitor the markets closely and maintain exchange-rate stability through currency board operations, the person said.

The Hong Kong dollar’s one-month implied volatility rose to 3.2 percent on Wednesday, the highest since December 2004, according to data compiled by Bloomberg. The currency was steady at HK$7.7511 versus the greenback.

The city linked its currency to the U.S. dollar in 1983, when negotiations between China and the U.K. over Hong Kong’s return to Chinese rule spurred a capital exodus. In 2005, policy makers committed to limiting the currency’s decline to HK$7.85 against the greenback and capping gains at HK$7.75. The city isn’t seeing large capital outflows amid the global stock rout, Hong Kong Financial Secretary John Tsang said on Monday.

“A depreciating yuan could perhaps make it easier for the Hong Kong and Chinese authorities to change the anchor of the currency peg, although there are few signs that a policy change will happen in the near term,” Barclays strategists Dennis Tan and Mitul Kotecha wrote in a note Tuesday. “We believe the Hong Kong government has a strong conviction that a fixed exchange rate is the best fit for a small, open economy with a large financial sector.”

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