* Dollar index hovers near 10-month peak after July rally
* Volatility ticks up from rock bottom, but jury still out
* Nonfarm payrolls data next major focus (Updates after start of European trade, changes dateline from previous SYDNEY/SINGAPORE)
By Patrick Graham
LONDON, Aug 1 (Reuters) - The dollar hovered around 10-month highs ahead of U.S. jobs data on Friday, the end of a third strong week which has hinted at an end to a year of chronically low volatility, low volumes and low trading returns.
Dollar bulls took a breather going into one of the most-watched piece of economic data, U.S. nonfarm payrolls. Dealers say another strong readout has the potential to make or break a rally that has seen the greenback post its best monthly performance in over a year.
The dollar index was up marginally at 81.51 just off a 10-1/2 month peak of 81.573. It has gained just over 2 percent so far this month.
"Its all or nothing today, I'd say," said one London-based trader. "There is the feeling that the euro has been forming a base over the last day or so, but either way payrolls should decide."
The euro was almost unchanged at $1.3382. It has fallen six full cents since early May, but proved more resilient on Thursday to another batch of upbeat U.S. data, which briefly sent U.S. Treasury yields to more than 2.6 percent.
Against the yen, the dollar gained just over 0.1 percent to 102.95 yen, also just below a four-month high of 103.15 yen struck on Wednesday.
Traders and investors have been pondering whether this is the beginning of a lasting uptrend, one that has frustrated dollar bulls for much of this year, or another false start.
The signs from options markets are positive but still extremely cautious. Volatility as measured by 3-month options contracts has risen steadily from record lows but remains at very low levels around 5.4. Currency platform and trading chiefs say they need vols of a minimum of around 7-8.
"It does feel like we've broken through the trendline support that has held for most of the past year," said Paul Robson, a currency strategist with RBS in London.
"The market are a little bit long dollars and if we do get an upside surprise on payrolls it may need to be a good bit higher than consensus. But on balance we like staying long dollars, with the yen maybe the cleanest trade on payrolls."
A Reuters survey of economists showed payrolls, due at 1230 GMT, probably increased by 233,000 in July.
While that would be less than June's hefty increase of 288,000 jobs, it would still represent a sixth straight month that employment has expanded by more than 200,000, a stretch not seen since 1997.
"If it comes in above 250,000, I think that's the threshold for a positive surprise," said Callum Henderson, global head of FX research for Standard Chartered Bank in Singapore.
Such an outcome could lift the dollar to levels around 103.50 to 104.00 yen, he said. Standard Chartered, however, is expecting nonfarm payrolls to increase by a below consensus 200,000, and for the dollar to pull back to levels around 102.50 yen, Henderson added.
(Editing by Jeremy Gaunt)