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US Dollar to Rally as Stocks Fall off Cliff

US Dollar to Rally as Stocks Fall off Cliff

2011-08-10 20:00:00
David Rodriguez, Head of Product
Share:

Forex futures and option sentiment points strongly in favor of further US Dollar (ticker: USDOLLAR) gains—especially against the Australian, New Zealand, and Canadian Dollars as stock markets plummet to multi-year lows.

Volatility expectations have broken to substantial highs, and we see strong evidence that the USD may have set an important bottom through recent trade. And though there is always risk of short-term correction (forcing a USD pullback), risks remain weighed in favor of Greenback gains.

As of very recently traders remained heavily net-short the US Currency across the board. Broader financial market deleveraging would likely force continued USD gains through the foreseeable future.

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

22.95%

17.54%

80.33%

94.83%

1.85%

3.33%

3.17%

1-Month

6.67%

1.89%

3.51%

98.15%

1.69%

3.39%

3.23%

3-Month

6.45%

1.96%

1.79%

96.15%

1.69%

3.39%

3.51%

12-Month

10.34%

12.73%

1.85%

98.08%

1.85%

3.28%

1.85%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

98.46%

98.41%

98.46%

98.46%

98.46%

forex_options_point_to_us_dollar_bottom_body_Picture_1.png, US Dollar to Rally as Stocks Fall off Cliff

Euro/US Dollar Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_2.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

Substantial forex market volatility has not translated into sharp Euro/US Dollar moves, and in fact the single currency seems comparatively insulated to broader financial market volatility. Our 3-month Risk Reversals percentiles once again called for a short-term EURUSD bottom as of August 4, and indeed the pair has since jumped by as much as 300 pips since.

Futures traders have aggressively pulled back long positions in the Euro/US Dollar and are in fact near turning net-short the EURUSD pair for the first time since January. This would be a fairly bearish signal and mark a potential turn in trend. We remain fairly bearish, but FX Options risk reversals have not quite given us a sell signal just yet.

British Pound/US Dollar Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_3.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

FX Options traders have moved aggressively towards betting on and hedging against further British Pound/US Dollar declines, pointing to further downside amidst currency market volatility. Given very short-term momentum, we suspect the GBPUSD could soon test psychologically significant congestion support near the 1.6000 mark, and further breakdown points to a re-test of 1.5400.

US Dollar/Japanese Yen Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_4.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

Options traders remain aggressively bearish the US Dollar against the Japanese Yen amidst a run towards fresh USDJPY lows. The USDJPY continues to break key psychologically significant support, and it is literally just pips away from post-war lows.

Continued trading around these levels increases the likelihood that we’re currently at a bearish sentiment extreme. Yet one-sided extremes are only clear in hindsight, and we see no compelling reason to establish a long position at these levels.

US Dollar/Canadian Dollar Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_5.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bullish

Major rallies in the US Dollar against the Canadian Dollar leaves options traders at their most bullish in the past 90 trading days, giving signal that the pair could continue higher amidst the sharp sentiment swing. The last time we saw a similar sentiment shift was when the pair saw a sustained shift through mid-May and subsequently hit multi-month highs.

It is difficult to say whether we can expect a sustained USDCAD rally, but the recent shift in sentiment leaves risks to the topside until further notice.

US Dollar/Swiss Franc Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_6.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

Fresh record lows in the US Dollar against the Swiss Franc have been met with aggressive bets on and hedges against USDCHF weakness. We have little choice but to favor continued weakness amidst the dramatic swing in sentiment. Of course, it is difficult to advocate for fresh short positions as potential risk outweighs potential reward. Indeed we may stick to the sidelines until we see signs of potential reversal.

Australian Dollar/US Dollar Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_7.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

FX Options and futures have grown aggressively bearish the Australian Dollar against its US namesake, warning of further losses as speculators unwind their long positions. Indeed, we write about clear risks to the Australian Dollar following the S&P downgrade of the US sovereign debt rating and subsequent equity market sell-off.

There is real risk that the AUDUSD can continue its decline as we feel the currency has under-priced the recent sell-off in ‘risk’ and change in market sentiment. Given that CFTC Commitment of Traders data showed speculators were near their most net-long on record, further de-leveraging could quickly force AUDUSD losses.

New Zealand Dollar/US Options Analysis

forex_options_point_to_us_dollar_bottom_body_Picture_8.png, US Dollar to Rally as Stocks Fall off Cliff

FX Options trading bias: Bearish

A substantial turnaround in New Zealand Dollar sentiment warns that this may be only the beginning of a larger move, and options traders are betting on and hedging against further declines. Given the severity of the sentiment correction, there is reason to believe that speculative futures traders may likewise shed long positions. CFTC Commitment of Traders data showed Non-commercial traders at their most net-long NZDUSD in history.

We see significant risk of further NZDUSD losses.

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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