(Adds quote, details, updates prices)
* Euro up after Merkel/Sarkozy pledge Greek support, but investors see default risk
* Options suggest more scope for euro downside
* Swiss franc pares losses vs euro after SNB reiterates currency stance
By Naomi Tajitsu
LONDON, Sept 15 (Reuters) - The euro rose on Thursday as assurances from Germany and France that Greece would stay in the euro zone quelled speculation that Athens may soon default on its debt, though the possibility of a future default kept the single currency vulnerable to more selling.
But the single currency retreated from the day's high versus the Swiss franc despite the Swiss National Bank reiterating its pledge to limit franc strength against the euro as investors questioned how long the central bank could maintain that policy.
The euro rose to a session high of $1.3826 after Wednesday's joint statement from Germany and France bolstered hopes that Greece will receive the next tranche of aid from the EU/IMF and avoid an immediate default.
Easing concerns of a near-term default has pulled the euro off a seven-month low of $1.3495 hit on Monday, but investors remained concerned such an event may unleash a major financial crisis in the euro zone and they remain ready to sell the currency and riskier assets into any rally.
"The fear of a chaotic Greek restructuring was driving weakness in the euro. That level of alarm and panic has subsided, but it's subsided only on crumbs of comfort," said Paul Frank, currency strategist at Societe Generale.
"The market needs more concrete events in the near term or else the euro dollar, instead of nudging up towards $1.40, will slide back towards $1.35."
He added that Greece's failure to secure more bailout funds could be the next trigger for more selling in the euro.
Investors were also conscious of rising speculation that Moody's will cut Italy's credit rating after the ratings agency said it may slash its Aa2 rating nearly three months ago.
Also keeping downward pressure on the euro is the view that euro zone rates will stay low after the European Central Bank shifted away from its hawkish stance on rates last week.
The correlation between euro/dollar moves and the spread between German and U.S. bond yields is beginning to strengthen following a weakening in past months, suggesting moves in bond yields may soon become a bigger driver for euro/dollar.
The euro hovered around $1.3800 in European trade, also supported by a near 2 percent rise in European shares .
But risk reversals, a measure of the premium required to hold a put or a call in a currency, continue to show a strong bias for euro downside, showing the market expects further falls in the single currency.
Many traders expect the euro to eventually test the recent low below $1.35, while resistance is seen at a previous support point around $1.3835 and then $1.3895, a 38.2 percent retracement of its fall this month.
DOUBTS ABOUT SNB
The euro is also burdened by mounting worries over the crisis spreading to the euro zone's bigger economies, prompting talk that joint euro zone bonds, which Germany strongly opposes, may be needed to instil confidence in the currency bloc.
U.S. investment bank Goldman Sachs has lowered its euro/dollar forecasts for the euro against the dollar due to rising tensions in the euro zone. It sees the euro at $1.40 in three months' time, versus a previous forecast of $1.45.
Gains in the euro knocked the dollar 0.3 percent lower to 76.571 versus a currency basket, while the U.S. currency was flat on the day at 76.57 yen .
The euro traded 0.1 percent higher on the day at 1.2055 francs, pulling back from a session high of 1.2094 but holding above the 1.20 floor set by the SNB last week in response to the franc's recent climb to record highs against the euro and the dollar.
The Swiss franc initially slipped after the SNB's quarterly policy announcement, when it also held interest rates and said it saw no imminent inflation risks.
A lack of price pressures would leave the SNB free to print as much money as it likes to cap the franc's gains.
But traders reported strong demand for euro/Swiss downside options, a sign that the market is sceptical about the SNB's ability to defend its target level.
"Risk reversals (are) very bid for downside, reflecting the fact that the market is worried about the SNB's ability to hold the 1.20 barrier over a longer period of time," CitiFX Wire said in a note. (Additional reporting by Neal Armstrong)