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US Dollar Forecast Bullish on FX Options Sentiment

US Dollar Forecast Bullish on FX Options Sentiment

2010-05-07 22:34:00
David Rodriguez, Head of Product
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Tremendous US Dollar and Japanese Yen rallies have led to similarly dramatic shifts in forex options market risk reversals, calling for further short-term USD and JPY gains. Our benchmark breakout risk reversal trading strategy has accordingly called for short USDJPY, EURUSD, GBPUSD, AUDUSD, and NZDUSD positions while the system has gone long the USDCAD. A surge in volatility expectations leaves them at their highest since the depths of the financial crises of late 2008 and early 2009, suggesting that currencies are likely to remain volatile through the coming week of trading.

 

Discuss outlook for individual currency pairs in our forex forums.
 
OW1
 
Euro/US Dollar Options Analysis

OW2

An astounding decline in the Euro has led to a similarly pronounced reaction out of FX Options markets, and risk reversals now heavily favor further EURUSD losses. Traders have aggressively bet on and hedged against Euro weakness through recent trading, and risk reversals are at their most bearish in at least the past seven years of trading. Similarly elevated volatility expectations leave scope for further losses, and it’s difficult to bet against recent downward momentum. 

 
 British Pound/US Dollar Options Analysis
 
 OW3
Similarly dramatic declines in the British Pound/US Dollar pair have pushed FX Options risk reversals to bearish extremes. Three-month risk reversals are now at their most negative since the GBPUSD set decade lows in late 2008, and elevated volatility expectations leave scope for further declines. Our benchmark breakout-style risk reversal system called for a short position through yesterday’s trade, and we accordingly remain bearish the GBPUSD until further notice.  
 
 

US Dollar/Japanese Yen Options Analysis
 
OW4
 
A substantial reversal in the US Dollar/Japanese Yen pair led to aggressive bets and hedges against further USDJPY weakness, leaving FX Options risk reversals at fresh extremes. Combined with heavily overbought net Non-Commercial futures positioning, evidence suggests that the USDJPY could fall further on an unwind in speculative positioning. Whether or not said forecast comes true will nonetheless depend on the short-term trajectory of the S&P 500 and other risky asset classes. A similar surge in volatility expectations on S&P 500 options leaves scope for further declines. 
 

US Dollar/Canadian Dollar Options Analysis
 
 OW5
 
Aggressive USDCAD rallies have been met with similarly aggressive shifts in forex options market risk reversals, leaving ample scope for further Canadian Dollar losses (USDCAD gains). Last week we hesitatingly called for a short-term reversal, and out of dumb luck or genuine skill we have seen exactly that. Heavily oversold net Non-Commercial futures positioning likewise leaves scope for further rallies as traders unwind leveraged positions. Our benchmark breakout-style risk reversals system called for a USDCAD long position on May 4, and we accordingly remain bullish the recently high-flying pair. 
 
 
US Dollar/Swiss Franc Options Analysis
 
 OW6
US Dollar sentiment against the Swiss Franc has improved considerably as of late, with longer-dated options putting a significant premium on out-of-the-money USDCHF calls. Combined with fairly net-long CFTC Non-Commercials futures positioning and general USDCHF strength, there is scope for further short-to-medium-term strength. 
 
 
 Australian Dollar/US Dollar Options Analysis
 
OW7
 
We have been caught on the wrong side of the AUD/USD trade an embarrassing number of times now, but the recent tumble gives reason to expect further declines in the high-flying currency pair. Heavily net-long Non-Commercial leaves the Australian Dollar in an overbought position, and the dramatic shift towards out of the money puts gives reason to remain bearish until further notice. Indeed, our benchmark breakout-style trading system called for an AUDUSD short on May 5 and we are accordingly bearish. 
 
 

New Zealand Dollar/US Dollar Options Analysis
 
OW8
 
Our short-term trading stance on the New Zealand Dollar/US Dollar currency pair is quite similar to that of the AUD/USD. Overbought Non-Commercial futures positioning leaves the New Zealand Dollar at particular risk of declines as traders unwind their leveraged positions. Our breakout-style risk reversal strategy called for a short on May 5 and we remain bearish accordingly.     
 
 
Written by David Rodríguez, Quantitative Strategist for DailyFX.com, drodriguez@dailyfx.com 
 

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