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Euro: Divergence in FX Options Sentiment Warns Top is Near

Euro: Divergence in FX Options Sentiment Warns Top is Near

2011-03-23 19:13:00
David Rodriguez, Head of Product
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An important divergence in Euro forex futures positioning and options sentiment data looks quite similar to what occurred at a major EURUSD top in late 2010, increasing risks of a material turnaround.

CFTC Commitment of Traders data shows that Non-commercial futures traders remain near their most net-long Euros since the pair made a run towards 1.60 in 2007. All the while, FX Options risk reversals show that many have in fact begun to bet on and hedge against EURUSD weakness.

The material divergence between these two typically-correlated measures of sentiment warns that there is increasingly little participation in EUR rallies. Such signs are reminiscent of the Euro’s topping in late 2010, and indeed risks remain weighed to the downside for the high-flying EURUSD.

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

24.52%

64.49%

27.39%

78.63%

80.29%

49.04%

66.23%

1-Month

38.71%

76.81%

38.93%

76.09%

31.03%

61.15%

68.35%

3-Month

35.48%

85.00%

53.69%

67.81%

27.46%

58.44%

62.59%

12-Month

39.73%

88.15%

48.20%

59.38%

10.64%

51.39%

54.30%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

60.00%

52.31%

40.00%

40.00%

45.31%

Euro_forecast_bearish_fx_futures_options_body_Picture_3.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

Euro/US Dollar Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_4.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

CFTC Commitment of Traders data shows that traders remain near their most net-long Euros since the pair traded on its way to the 1.60 mark in 2007, but a recent pullback in FX Options risk reversals suggests that many are not betting on/hedging against continued strength. Indeed the strong divergence between FX Options sentiment data is reminiscent of the similar moves we saw in late September/early November of last year.

Non-commercial futures positioning hit fresh bullish extremes, but a noteworthy pullback in risk reversals warned of waning interest in Euro longs. It is exceedingly difficult to time reversals, but the Euro could soon set an important top and reverse sharply against the US Dollar.

British Pound/US Dollar Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_5.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

The British Pound has defied expectations and remained near fresh highs, confounding those on the DailyFX team that sought to go short the high-flying pair. Commitment of Traders data nonetheless shows that Non-commercial traders have significantly scaled back long positions and are effectively neutral as of recent reporting. FX Options risk reversals show that many have moved to bet on and hedge against GBP strength.

Given such divergent signals, we are reluctant to take a strong stance on the GBPUSD until further clarification in sentiment.

US Dollar/Japanese Yen Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_6.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

Incredible Japanese Yen volatility has forced dramatic moves in FX Options risk reversals, but it is interesting to note that most recent readings show many have maintained bets on and hedges against Japanese Yen gains (USDJPY weakness) despite the threat of forex market intervention. The USDJPY’s 3-month 25-delta Risk Reversal shows traders are near their most bearish the USDJPY since November. And though said risk reversal rate has moved considerably off of recent lows, the fact that it remains bearish implies that options traders are not especially worried about lasting G7 forex market intervention.

US Dollar/Canadian Dollar Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_7.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

A dramatic US Dollar reversal against the previously high-flying Canadian Dollar could be the start of a larger correction as traders exit leveraged positions. In past weeks we have warned that net Canadian Dollar Non-commercial positions were at their most net-long since the pair neared an important bottom in late 2007. The material reversal suggests that we may have recently hit a bullish sentiment extreme in the Canadian Dollar (bearish in USDCAD), and indeed FX Options risk reversals show that many have begun to bet on and hedge against further USDCAD rallies.

Our benchmark breakout-style risk reversals trading signal hypothetically went long as of March 15 near the 0.9860 mark, and a further deleveraging across financial markets would likely force continued USDCAD rallies through the foreseeable future.

US Dollar/Swiss Franc Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_8.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

Traders have grown aggressively bullish the Swiss Franc as it continues to set fresh record-highs against the US Dollar. COT data shows Non-commercial traders at their most net-long the Swiss Franc (net-short the USDCHF) since December, 2009. FX Options risk reversals likewise show that many continue to aggressively bet on and hedge against further Swiss Franc strength (USDCHF weakness). It is very difficult to advocate for a USDCHF short position as the pair trades at record-lows, but we would need to see a material reversal in price to call for a reversal all the same.

Australian Dollar/US Dollar Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_9.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

The Australian Dollar continues to defy calls for a sustained pullback, rallying sharply after initial signs that it could continue lower through recent trade. We have argued that the AUDUSD was at risk of significant reversal as COT data showed net Non-commercial positioning at its most net-long since the pair set an important top in early 2010. Indeed, FX Options risk reversals subsequently hit their most bearish in the preceding 90 days, and our benchmark breakout-style system hypothetically went short as of March 15 near 0.9910. Yet said trade was subsequently closed out at a loss, and we await further signs of important pullback before renewing our calls for AUDUSD weakness.

New Zealand Dollar/US Options Analysis

Euro_forecast_bearish_fx_futures_options_body_Picture_10.png, Euro: Divergence in FX Options Sentiment Warns Top is Near

Recent New Zealand Dollar price action closely resembles that of the Australian Dollar, and the NZDUSD has likewise defied calls for continued declines through recent trade. Our benchmark breakout-style risk reversals system hypothetically went short the NZDUSD as of March 15 near the 0.7320 mark. Yet said position has been closed out at a modest loss as the pair has quickly regained ground.

Recent Commitment of Traders data shows that Non-commercial traders are now net-short the NZDUSD. Said fact suggests that the pair is subsequently less likely to see large corrections on a deleveraging across financial markets. Our short-term bias is admittedly unclear.

Written by David Rodríguez, Quantitative Strategist for DailyFX.com, drodriguez@dailyfx.com

To be added to this author’s distribution list, send an e-mail subject line “Distribution list” to drodriguez@dailyfx.com

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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