FOREX NEW YORK COMPANIES

* Traders cite option barriers at $1.2500, stops at $1.2480

* Uncertainty in Greece keeps sentiment bearish

By Anirban Nag

LONDON, May 25 (Reuters) - The euro inched up from two-year lows against the dollar on Friday as bearish investors took a breather from a sharp sell-off this week, but worries about a possible Greek exit from the euro zone and the risk of contagion could make gains fleeting.

The euro traded 0.4 percent higher on the day at $1.2581 , pulling away from $1.25155, the lowest level since July 2010 that was hit the day before. Traders cited a reported option barrier at $1.2500 that could check losses with offers around $1.2600 and stop-loss orders above $1.2620.

Despite the bounce, the common currency has lost more than 5 percent against the dollar so far this month and is on track for its fourth straight week of losses, raising the possibility of a test of the 2010 low of $1.1875.

Macro funds and institutional investors have ramped up euro selling after an inconclusive election in Greece left the country at risk of bankruptcy and a possible exit from the euro zone. Greeks vote again on June 17, with polls showing a close race between parties supporting and opposing terms of the country's international bailout, keeping markets on tenterhooks.

"The euro is a bit higher today, but I will be surprised if it takes stops above $1.2620. The medium-term prospects are not good," said Geoff Kendrick, currency analyst at Nomura.

"We think if Greece does not exit the euro zone, the euro will see a gradual decline to $1.23 in coming months. But if it does, then we see the euro falling to $1.20 by the end of the second quarter and $1.15 by the end the third."

Investors are also concerned about the health of the Spanish banking sector, chances of a deep and damaging slowdown in the euro area and the lack of any aggressive policy measures to address the escalating debt crisis.

Spanish lender Bankia, which was part nationalised this month, was set to ask the government for a bailout of more than 15 billion (US$19 billion) on Friday.

Many strategists expected euro selling to resume next week, although heavy short positioning would slow the momentum.

"We have got a standoff where the market is short and the news is bad and so we have tended to go down in stages," said Kit Juckes, currency strategist at Societe Generale.

"Although it's almost impossible to imagine a set of circumstances where we get good news. The pullbacks in this move down since the break of $1.30 have got really tiny."

DARKENING PICTURE

Investor skittishness was well-reflected in the options market, where euro/dollar one-month implied volatility spiked to 13.13 percent, its highest in more than four months.

With the euro on the backfoot the dollar has been the chief beneficiary, with its index against a basket of major currencies edging up to 82.411, the highest since September 2010.

Against the yen, the dollar was steady at 79.51 yen, supported by Tokyo importers and investors squaring positions ahead of a long weekend in the United States. Sell offers around 80.00 yen were poised to cap any further gains, traders said.

The euro was flat against the Swiss franc at 1.2015 francs, having jumped to 1.20769 francs on Thursday, its highest since mid-March on market talk the Swiss government is going to impose a tax on deposits and chatter that the Swiss central bank initiated a short squeeze in the pair.

Traders said the Swiss National Bank has been buying euros in the past few weeks to protect the floor at $1.20 francs, although some investors were still piling on bets through the options market that the peg will be breached in coming days if the euro zone crisis escalates.