Euro Poised for Breakout

by Richard Ilczyszyn and Phil Streible

The euro seems poised to make a breakout against the U.S. dollar, but the big question is which direction. It could go either way as we have global inflation, and at the same time, economic weakness impacting the currencies. We think a strangle is a good strategy traders can consider, this being the case.

The dollar hit a two-week high against the euro on Thursday, July 24, 2008, after the House of Representatives approved a rescue package that gives Treasury Secretary Paulson authority to buy shares in and lend funds to ailing lenders Fannie Mae and Freddie Mac. Earlier this week, Philadelphia Federal Reserve Bank President Charles Plosser said in a speech in King of Prussia, PA, that the U.S. central bank should raise interest rates “sooner rather than later,” also giving the dollar a boost.

Hower, at this time, we have a slightly bullish bias on the euro. The European Union’s one central policy is to fight inflation, which has kept them in tightening mode, strengthening the euro. The ECB last increased its refinancing rate to 4.25 percent on July 3, citing inflation. Inflation in the euro zone is estimated at about 3.4 percent this year, above the limit the ECB considers consistent with price stability. Money supply has been growing at a rate above 4.5 percent every month since May 2001.

Here in the U.S., there has been concern about mounting inflation as well, and thoughts interest rates are too low and need to move up to counter it. However, given the breakdown in the financial markets and the issues surrounding Fannie Mae and Freddie Mac right now, we don’t think the Federal Reserve is likely to raise short-term term interest rates at its next policy meeting on August 5, 2008.

So we see the euro likely to see a range of $1.52 on the low side, and $1.60 on a high side for the time being, but a bigger move is likely ahead as some of these fundamental factors play out. Buying a strangle is a good way to play an explosion in either direction, when you aren’t sure which direction it will be. It also offers defined risk, and unlimited potential. We recommend looking at the August euro options for a move in the next couple weeks. The options expire August 8, right when the Olympics start.

CME euro futures are currently trading near $1.5678, so consider the 156 put, and work a limit order around 65 points. Multiplying that by 11.2, and you get a cost of $728 to buy the put. Then work another limit order at 65 points for a 157.50 call, also, $728. So your cost on the trade is $1,450 (plus your commission charges), which is your defined risk.

Feel free to call us with any questions you have about this strategy or others to suit your particular account size and risk tolerance. Ask about our special half-off commissions offer for new clients.

Richard Ilczyszn is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-605-0095 or via email at rilczyszyn@lind-waldock.com.

Phillip Streible is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com.

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