Oct. 29 (Bloomberg) -- Options traders are paying the biggest premiums since December to buy protection against a gain in the dollar versus the euro on speculation the Federal Reserve may temper its commitment to keeping borrowing costs low.

The one-month 25-delta risk-reversal rate for the euro versus the dollar declined to minus 0.82 percent today, the lowest level since Dec. 11. A negative reading indicates traders pay more to buy euro puts, or the right to sell the currency, than for calls, or the option to buy the currency.

“It’s rather unusual that the option market pays so much premium without extreme” changes in exchange rates, said Harald Hild, a portfolio manager at Quaesta Capital Optivest AG in Switzerland, who traded options for 15 years. “The market is getting nervous.”

The dollar touched a 14-month low of $1.5063 per euro on Oct. 26 on speculation the Fed will keep its target lending rate near zero into next year, encouraging investors to buy higher- yielding assets at the expense of the greenback. The dollar gained versus the euro the past four days on concern global policy makers would withdraw economic-stimulus measures, damping demand for high-yielding assts. The greenback dropped to $1.4859 per euro today.

Fed officials are likely to discuss next month how and when to signal the possibility of higher U.S. interest rates, the Wall Street Journal reported on Oct. 24, without citing anyone.

Net Short Position

Members of the central bank are beginning to consider the best communications strategy for letting the market know that an “extended period” of record-low rates will draw to an end, the Journal said. The issue may be “on the table” when the Federal Open Market Committee meets Nov. 3-4, the newspaper wrote.

Hedge funds and other large speculators pared their bets that the dollar will continue declining versus the euro in the last two weeks, figures from the Washington-based Commodity Futures Trading Commission show.

The so-called net shorts on the dollar, the difference in the number of wagers on a decline compared with those on a gain, fell to 36,033 on Oct. 20, from a 21-month high of 51,045 two weeks earlier.

The premium for protection against the dollar’s rebound will decline because the Fed won’t raise rates any time soon, Hild said. It will be profitable to use options to bet currency volatility will decline, he added.

The implied volatility on the one-month options for the euro versus the dollar declined to 10.48 percent, from 11.15 percent yesterday, indicating investors see less price swings in coming weeks. The gauge increased in each of the past three days. Volatility tends to increase during period of economic uncertainty.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.netChris Fournier in Montreal at cfournier3@bloomberg.net

Last Updated: October 29, 2009 14:50 EDT