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Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

By , Quantitative Strategist
27 October 2011 09:00 GMT

As of the most recent CFTC Commitment of Traders report, Non-commercial traders remained near their most bullish the US Dollar against the Euro since the EURUSD set a significant bottom near 1.20 in 2010. A subsequent rally suggests many covered their shorts, but positioning remains quite extreme and we see further scope for EURUSD short covering.

There’s considerable uncertainty surrounding major pairs, but overall positioning and sentiment suggests that the US Dollar may continue to trade lower.

Watch a presentation on how you can use FX Options risk reversals and this report in your swing trades.

Risk Reversals

EUR/USD

GBP/USD

USD/JPY

USD/CAD

USD/CHF

AUD/USD

NZD/USD

1-Week

37.08%

57.65%

69.05%

80.23%

74.42%

15.73%

15.56%

1-Month

19.54%

32.05%

63.75%

77.65%

72.62%

23.60%

24.72%

3-Month

15.29%

32.10%

55.95%

78.31%

83.33%

23.86%

24.14%

12-Month

23.17%

28.40%

60.26%

77.11%

97.56%

12.36%

23.86%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

58.46%

60.00%

44.62%

41.54%

50.00%

forex_trading_forecast_euro_us_dollar_body_Picture_1.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

Euro/US Dollar Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_2.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Contrarian Bullish

Exceedingly choppy Euro/US Dollar price action has made for difficult trading, but the EURUSD seems stuck within its recent uptrend and we have little option but to further a test of further highs.

CFTC Commitment of Traders data recently showed Net Non-Commercial positioning was at its most bearish EURUSD since the pair set a significant bottom near $1.20 in mid-2010. The recent weeks’ rally seems a sharp correction from this bearish extreme. Yet it is difficult to gauge whether further short-covering rallies are likely, and we are only cautiously bullish.

US Dollar/Canadian Dollar Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_3.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Bearish

CFTC Commitment of Traders data recently showed that Non-Commercial trades remained near their most net-long USDCAD since 2009—at which point the USDCAD set an important high near the C$1.20 mark and continued lower.

Already we’ve seen the USDCAD pull back significantly off of recent peaks near the C$1.0650 mark, and the question now becomes whether we can expect further corrections through upcoming trade.

To that end, we note that our proprietary Speculative Sentiment Index data shows that the number of retail traders long USDCAD outnumber those short by a noteworthy 2 to 1. Such one-sided positioning gives us contrarian signal that the pair may continue lower.

Australian Dollar/US Dollar Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_4.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Neutral

Much like in other US Dollar pairs, CFTC Commitment of Traders data recently showed Non-Commercial traders at their most bullish the USD against the Australian Dollar since the pair set a significant bottom in 2010. Positioning has since corrected somewhat, and the AUDUSD is dramatically off of its lows.

The critical question remains whether we can expect further AUDUSD short covering and continued strength. Given recent trends towards US Dollar weakness, we suspect the AUDUSD could trade to further highs. Yet we remain only cautiously bullish as the risk of short-term reversal remains high.

British Pound/US Dollar Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_5.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Contrarian Bullish

We recently argued that extremely bearish GBPUSD sentiment suggested the pair could correct higher, and indeed it now trades significantly off of its recent lows. Sentiment remains quite bearish, and CFTC Commitment of Traders data shows that Non-commercial traders remain near their most net-short since the pair bottomed through mid-2010.

It seems as though the GBPUSD may have further room to rally as traders cover short positions. Yet we are far less bullish than we were just two weeks ago—especially as markets have seemingly entered tight and choppy trading ranges.

New Zealand Dollar/US Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_6.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Contrarian Bullish

The New Zealand dollar remains in an unsurprisingly similar position as that of the Australian Dollar. NZDUSD options sentiment was recently near its most bearish since the pair set a significant bottom near $0.65 in early 2010. CFTC Commitment of Traders data likewise showed that traders have aggressively pared bets on NZDUSD strength.

The combination showed that the pair was likely to correct significantly off of its lows. Indeed, we’ve seen a major bounce, and there’s a reasonable chance the NZDUSD could continue trading higher. Yet we are far less bullish than we were weeks ago.

US Dollar/Japanese Yen Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_7.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Bearish

A sharp break lower in the USDJPY has been met with a fairly significant pullback in USDJPY options risk reversals. Yet it’s interesting to note that options traders are far less bearish than they were through early August when the pair first traded to fresh modern lows. CFTC Commitment of Traders data likewise shows that Non-Commercial positioning is far less bearish than it was previously.

There are two ways to interpret the disconnect between price and sentiment. We may be seeing a bullish divergence between trader positioning and price—giving signal that the pair could soon reverse and trade higher. Yet it is likewise possible that relatively neutral positioning leaves plenty of room to run for further USDJPY-short positions.

Our Speculative Sentiment Index data shows that the number of retail traders long the USDJPY outnumber those short by a whopping 13 to 1. Such incredibly one-sided sentiment gives us contrarian signal that the pair may trade to fresh lows.

US Dollar/Swiss Franc Options Analysis

forex_trading_forecast_euro_us_dollar_body_Picture_8.png, Options Show US Dollar Poised For Losses, but Risk of Reversal Grows

FX Options trading bias: Bullish

The US Dollar/Swiss Franc pair matches the profile of the Euro/US Dollar and other key pairs; traders were aggressively net-long USD until a fairly recent pullback. CFTC Commitment of Traders data shows Non-Commercial traders were recently their most net-long USDCHF (short CHF futures) since the pair set a significant top in May, 2010.

All else remaining equal, broader US Dollar losses favor continued USDCHF weakness. This would be consistent with a pullback in USDCHF-long positions.

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To contact David, e-mail drodriguez@dailyfx.com

To be added to David’s e-mail distribution list for this and other reports, e-mail subject line “Distribution List” to drodriguez@dailyfx.com

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27 October 2011 09:00 GMT