Question: Consider the following episode: EUR/USD one-month implied volatility sank by 2.7% to 10% Wednesday as traders hedged this euro exposure against the greenback, as the euro plunged to historic lows on the spot market. After the European Central Bank raised interest rates by 25 basis points, the euro fell against leading to a strong demand for euro Puts. The euro touched a low of USD0.931 Wednesday. (Based on an article in Derivatives Week.)
a. In the euro/dollar market, traders rushed to stock up on gamma by buying short-dated euro puts struck below USD0.88 to hedge against the possibility that the interest rates rise. Under normal circumstances, what would happen to the currency?
b. When the euro failed to respond and fell against major currencies, why would the traders then rush to buy euro puts? Explain using payoff diagrams.
c. Would a trader "stock up" gamma if euro-triggered barrier options?