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US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

2011-05-18 16:30:00
David Rodriguez, Head of Business Development
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A strong pullback in FX Options sentiment and forex futures positioning supports calls for continued US Dollar strength against the Euro, Australian Dollar, British Pound, and Canadian Dollar through near-term trade.

FX Options and futures traders have aggressively pulled back bets on continued US Dollar weakness, and a similar reversal in key USD pairs points to a potentially significant Greenback bottom. Indeed, our benchmark FX Options risk reversals system has now hypothetically gone long the US Dollar against the Euro, British Pound, Canadian Dollar, and Australian Dollar. A continued correction in sentiment and positioning would further support the US currency through near-term price action.

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

18.33%

2.04%

62.07%

94.55%

6.56%

22.58%

24.14%

1-Month

9.09%

1.85%

66.67%

96.36%

39.34%

21.67%

24.56%

3-Month

9.84%

8.33%

73.21%

98.31%

46.30%

14.29%

15.52%

12-Month

12.50%

57.78%

92.59%

100.00%

60.38%

73.68%

8.33%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

83.08%

81.54%

85.71%

84.62%

83.08%

us_dollar_forecast_forex_futures_options_body_Picture_1.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Euro/US Dollar Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_2.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Our benchmark FX Options risk reversals trading system hypothetically took a EURUSD-short position as of May 13 at approximately the 1.4120 mark, pointing to further declines on the sharp sentiment swing. The most recent CFTC Commitment of Traders report likewise shows that Non-Commercial traders—typically large speculators—scaled back aggressively on EURUSD longs as of early last week.

We have persistently warned that a sentiment extreme may have been developing as traders had grown very heavily net-short the US Dollar. The recent correction from USD-bearish extremes suggests this could be the start of a larger correction and points to EURUSD declines.

British Pound/US Dollar Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_3.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

A noteworthy pullback in the British Pound has been met with a similarly pronounced correction in FX Options risk reversals, suggesting that the GBPUSD has likewise set an important top through recent trade. Our benchmark FX Options risk reversals trading system is very close to hypothetically establishing a short position, and the severity with which sentiment has shifted warns this could be the start of a larger move.

CFTC Commitment of Traders data shows Non-Commercial traders scaled back GBPUSD longs through early last week. A further deleveraging in GBP bets could further fuel a US Dollar short-covering rally.

US Dollar/Japanese Yen Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_4.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Japanese Yen futures and options trader sentiment continue to show mixed signals for the USDJPY, giving us little conviction in our sentiment-based forecasts. The currency pair remains in a secular downtrend since peaking in late 2007. All else remaining equal, the persistent downtrend favors further declines through the short and medium term. A recent improvement in FX Options Risk Reversals sentiment suggests that the pair could inch higher, but it isn’t a strong-enough move to take an aggressively bullish bias.

US Dollar/Canadian Dollar Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_5.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Our benchmark breakout-style risk reversals trading system hypothetically went long the USDCAD from May 4 at approximately the C$0.9595 mark, and an important shift in sentiment points to further gains. We have long argued that extremely one-sided Non-commercial futures positioning warned that a USDCAD short-covering could force substantive strength. A continued shift towards bets on and hedges against USDCAD would point to further rallies.

Indeed, recent CFTC COT data shows that large speculators pared their bets on Canadian Dollar strength (USDCAD weakness). A continued short covering could produce further short-term strength.

US Dollar/Swiss Franc Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_6.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Aggressive week-to-week shifts in FX Options risk reversals make it difficult to establish a lasting bias in the USDCHF pair. Our benchmark FX Options risk reversals system hypothetically went short USDCHF on March 17 near the SFr 0.9165 mark and closed it as of May 6 near 0.8790. Risk reversals subsequently spiked higher on the short-term US Dollar correction but have since declined. All the while, CFTC Commitment of Traders data shows that speculators have modestly pared their bets on Swiss Franc strength (USDCHF weakness).

We will wait for a more lasting shift in sentiment before taking an aggressive stance on the USDCHF. All else remaining equal, its strong downtrend favors continued weakness.

Australian Dollar/US Dollar Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_7.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

Our FX Options risk reversals trading system hypothetically went short AUDUSD from May 12 near the 1.0680 mark, as a strong shift in market sentiment suggests the pair may have set an important top. CFTC Commitment of Traders data likewise shows that large speculators pared their bets on Australian Dollar strength through early last week. We have continued to warn that the AUDUSD could set an important top on a potential bullish sentiment extreme.

The fact that we have seen multi-year peaks amidst record-long positions in the AUD and since pulled back suggests that this is the reversal we have been waiting for.

New Zealand Dollar/US Options Analysis

us_dollar_forecast_forex_futures_options_body_Picture_8.png, US Dollar Likely to Rally as Futures and Options Positioning Pulls Back

An important reversal in FX Options sentiment warns that the New Zealand Dollar could continue lower against its US namesake, and our benchmark FX Options risk reversals system went short as of May 17. It is interesting to note that recent CFTC Commitment of Traders data actually showed growth in NZDUSD longs, however. Said fact suggests that many speculators have not given up on further NZDUSD gains.

Although CFTC COT data does not yet confirm, we may have seen an important turn from NZDUSD sentiment extremes and a potential top is in place.

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

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