EWJ: Why You Should be Aware of Foreign Currency
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Americans are so used to having a globally dominant currency that I think we sometimes forget that the U.S. dollar is just another social contract. Like every other "store of value," it is only worth whatever goods or services someone else will give us for it. I lived in Scotland for a little while, and I remember being struck by how much more aware friends there were of other currencies and exchange rates.
Currency pairs and related assets can get confusing sometimes, so I thought I would explain the details of Japanese Yen-linked assets for readers who don't regularly look at foreign exchange markets. A long iShares MSCI Japan Index (EWJ) position is one of my picks for 2013, and tomorrow I want to take a closer look at JPY/USD volatility skew because there's something instructive going on there.
Here are the main assets you should know about.
JPY/USD futures and options on those futures trade at the CME. The current contract, for December 2012 expiration, is priced at 0.012194, which means that if you give me $0.0122 cents, I'll give you ¥1 in return. A mental trick to make sense of the price quote for any X/Y pair is to think, "If I give the market one X, how many Ys can I get in return?"
The spot forex market trades USD/JPY instead, so you will see quotes in the 82 range. That is, if you give the market $1, you can get about ¥82 in return. Note that these are clean, neat ratios: 1 / 0.012194 = 82.0075
There is also an ETP, CurrencyShares Japanese Yen Trust (FXY), that trades about 260,000 shares and 3000 option contracts per day. The price of FXY reflects the value, in dollars, of its yen holdings. So for the yen Xs held in the fund, the market price of the Trust is Y. As you might expect, then, FXY is a proxy for the JPY/USD or 6J futures. FXY was listed in early 2007, so that's why, to get much historical context, we have to look at other assets.
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