Taking Advantage of the U.S. Dollar’s Volatility
by Tim Evans
Traders that haven’t been involved in the energy or grain markets may have felt a little left out this year. Unless you’ve been on long side of these markets, you’ve probably been exposed to a lot of volatility that has made it hard to make profitable trades. Because the U.S. dollar has affected those markets and others, let’s look at some dollar trading strategies.
How can we take advantage of the conditions in the U.S. dollar? If you’ve traded currencies before, you know that the money follows the yield. Countries that have high interest rates have currencies that are appreciating in value.
The U.S. Federal Reserve has obviously gone through a period of rate cuts going back to August 2007 to fight off problems in the real estate sector and numerous other economic issues. It’s pretty fair to say that the U.S. economy hasn’t been performing that well recently, and I wouldn’t expect much to change in the near-term.
As the Fed has been cutting rates, this has contributed to higher commodity prices. This has helped create an inflationary economy. The Consumer Price Index (CPI) has been rising faster and the Fed is now in a predicament over what to do with interest rates.
To fight off economic weakness, it would need to lower interest rates, but that could lead to higher inflation. Alternatively, the Fed could raise interest rates to lower inflation, but that would negate the earlier rate cuts that we are still waiting to absorb into the economy.
Because of this conflicting problem, it is widely expected that the Fed will keep rates steady at the Federal Open Market Committee (FOMC) meeting on June 25. The U.S. dollar should continue to be volatile while trading in the same range it has in the last three months.
Meanwhile, it’s worthy to take note of weakness in the euro-zone. There has been speculation that the European Central Bank will raise interest rates to fight off inflation. The dollar has fallen recently based on this possibility, but I expect Europe to also keep rates steady as it waits for more economic data.
From a technical basis, this market is pretty much trapped between the 50-day moving average and the 200-day moving average. This market seems range bound, as there is a lot of support at the 50-day moving average and a lot of resistance from the 200-day moving average.
If you have never traded currencies before, U.S. Dollar Index futures are one way to gain exposure to this market. The index is a weighted average of six major currencies against the U.S. dollar and trades at ICE. This market gives traders a good feel for how the dollar is performing against the major currencies of the world.
A strategy I’ve been recommending to my clients depends on taking advantage of the volatility in the U.S. Dollar Index, with the expectation that it will probably continue to trade in a range. If we expect the dollar to trade in a range, we can set up an options position that will bring in premium if the market stays within a specific range.
Option premiums are usually high when volatility is considered high. Since we’ve seen high volatility and expect the dollar to trade in a range, I would recommend selling an at-the-money call and an at-the-money put. This strategy is known as a straddle. By selling the option, you are looking to bring in a certain amount of premium in the hopes that the market stays within a specific trading range. Keep in mind that these markets are changing day-by-day. If you’d like specific strike prices and price breakdowns, you are more than welcome to call me at 800-798-7671.
There is risk to taking on a trade like this. When you sell an option, your risk is unlimited, so the trade has to be carefully managed. I help my clients manage these types of positions based on their account size and risk tolerance.
Tim Evans is a Senior Market Strategist with Lind Plus. He can be reached at 800-798-7671 or via email at tevans@lind-waldock.com.
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*No representation is being made regarding the actual or hypothetical performance of the systems at any other brokerage firm or prior to the dates reflected above. These numbers include commissions, but not fees. Contrary to most published results, please note that these monthly returns are calculated based on closed trade profit/loss and do not include changes in open trade equity. Futures trading involves the substantial risk of loss and may not be suitable for all investors. Past performance is not necessarily indicative of future results. All information, including performance and program description, has not been reviewed or verified by Lind-Waldock.
