Options Trading Ideas: Take Advantage Of The Near-Term Dollar Weakness, But Also Hedge Against A Potential Change In Trend

Fundamentals

Dollar index futures look poised to resume their downtrend, after the Group of Seven (G7) meeting this past weekend in Istanbul failed to formally address any plans to halt the U.S. Dollar’s decline. This came as a bit of a surprise to some traders, who thought leaders from the European Union and or Japan would strongly voice their concerns that recovery efforts in Europe and Japan were being hampered as a rising Euro and Yen continued to hurt exports. However, officials were more vehement to address Chinese currency concerns, as the call continues to go out for China to allow the Yuan to appreciate in value. Though intervention in the FX market weakening one’s own currency is possible, there have been few signs that European and Japanese central banks are ready to make such a move, despite some calls from manufactures to do so. Speculators are already onboard the bearish Dollar bandwagon, according to the most recent Commitment of Traders report. As of September 29th, large and small speculators are holding a net long Euro/Dollar position of nearly 66,000 contracts, as well as a net short position of 9,790 contracts in the Dollar index. This relatively large one-sided position against the greenback has some traders looking for a strong correction in the Dollar, as speculators rush for the exits should we start to see some Dollar positive news hit the markets. However, with the U.S. Government’s seeming approval of a weakening Dollar to aid U.S. exporters, it appears that only a change in policy by foreign Central Banks to intervene in the FX markets to buy U.S. Dollars will catch the attention of speculators and potentially put at least a temporary halt to the Dollar’s decline.

Trading Ideas

Given that the current trend in the Dollar Index is bearish, but with the potential that we could see a short-covering rally by year’s end, some traders may wish to explore strategies that not only take advantage of the near-term weakness, but also hedge against a potential change in trend. One such strategy would be buying a calendar spread in Dollar Index options. An example of this trade would be buying the December 78 calls and selling the November 78 calls. With the December Dollar index futures trading at 76.91 as of this writing, the calendar spread could be purchased for about 35 points, or $350 per spread plus commissions. The premium paid is the maximum risk on the trade. The position would benefit from increasing time decay in the November options — especially if the Dollar index futures price holds relatively steady as expiration of the November contract approaches during the first week of November.

Technicals

Looking at the daily chart for the December Dollar Index, we notice the market struggled to hold above the 20-day moving average after this past weekend’s G7 meeting did little to alter the Dollar’s bearish bias, but bearish fundamentals ultimately prevailed. More importantly, we would need to see a nearly 200-point rally in the DX in order to approach the 100-day moving average that many technical traders use as a gauge to assess whether a market is in a bullish or bearish mode. The 14-day RSI could barely move above the 50-level on the recent minor upswing before turning lower on Friday’s sell-off. The recent lows made on September 23rd at 76.045 remain key support for the December contract. Last week’s high of 77.735 made on September 29th looks to be the next resistance point.

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