Using Forex Options To Trade The Uncertain Euro Outlook

Fundamentals

The Euro is slightly higher this morning in very quiet trading. The currency surged yesterday on comments made by Treasury Secretary Geithner indicating the US may be open to having a global reserve currency. The Euro gave back a good portion of these gains after the comment was rescinded. It appears that Mr. Geithner has not yet realized that his comments can send the markets into flux, especially if said comments can be viewed as negative for the greenback or the equity markets.

Turning to the larger picture, it appears that Eurozone leaders will err on the side of an eventual economic recovery in regards to interest rate easing and stimulus spending. The bank continues to remain cautious of inflationary pressure caused by aggressive interest rate cutting. This is because Western Europe is extremely sensitive to rising costs, more-so than the US and developing nations.

The US and Europe seem to be heading in different directions in this regard, with the US being fast and loose with government spending and Europe being quite conservative. Economic data suggests that both would be better suited taking the exact opposite approach. The global economic meltdown started in the US and the economy here has already suffered blows equivalent to a 10 round heavyweight boxing match, while the EU is still in the sixth round.

Data also suggests that the EU economy will lag behind the rest of the world when a global recovery eventually comes. How currency traders react to the recent developments is still up in the air.

The Euro has positive interest parity with the greenback, and the Yen and the massive Fed bond and toxic debt purchase plans certainly favor a weaker US Dollar. Also, if the equity markets continue to rally, it is a clear sign that investors are willing to take risks once again. This can be viewed as negative for the Dollar, as overseas investors parking their money in the world’s reserve currency may repatriate funds. On the flip side of the stronger Euro argument is the economic weakness of the Eurozone itself. There have been a handful of positive economic reports in the US, suggesting at the very least that the slowdown could be bottoming. The Eurozone lacks similar data.

Also, infighting between “Old Europe” and “New Europe” can be seen as counter-productive and negative for the Europe. Given the general confusion as to the direction of the currency markets, traders may be looking to play both sides of the fence.

Traders believing that the Euro will move sharply, but who are uncertain which direction that will be, may wish to employ a long strangle trade, buying the May 1.30 put and buying the May 1.40 call for a debit of 0.0300, or $3,750. If held until expiration, the June Euro would have to close above 1.43 or below 1.27 for traders to begin to profit from the spread, excluding commissions. Given the cost of the spread, traders may wish to close the put side on solid closes above 1.3730 to salvage some of the value of this option, while letting the call side run. Conversely, the call may be closed on solid closes below the 1.3300 level for the same reason.

Technicals

The June Euro chart is a land of confusion. The chart appears to be in the midst of forming a bull flag formation, but a closer look at the candlesticks comprising the flag suggests a possible reversal may be in the works. Monday’s price action forms a spinning top pattern with a long upper and lower wick, followed by a down day on Tuesday. The market was sharply lower yesterday before the Geithner snafu, suggesting traders were in bear mode before the surprising comments. The June contract also finished 89 points below intra-day highs.

Prices have also hit a wall at the 1.3730 area, which is a relative high close from January and can be seen as resistance. A close above this level would not only signal a breakout above resistance, but confirm the bullish flag formation. The 50-day and 100-day moving averages are touching and may cross over, suggesting the long term trend may favor the bulls.

Subscribe by RSS Subscribe by Email