Here's How I'd Trade USD
Jay Kaeppel | Nov 15, 2017 01:39PM ET
The U.S. dollar attempted to rally, recently, following a pretty relentless January-into-September decline. Is that rally over? And if so, is there a play to be made?
Figure 1 displays ticker UUP, an ETF that tracks the U.S. Dollar Index.
Courtesy ProfitSource by HUBB
You can see the long decline in 2017, the recent rally and now an Elliott Wave “Wave 4 Sell” as generated by ProfitSource by HUBB. Does this guarantee that the next down leg in the dollar has begun? Not at all. First off, Elliott Wave counts can be a bit nebulous at times. Also, not every “Elliottician” will agree with the count as it appears in Figure 1 (in fact, trying to get two Elliott counters to agree on a given count is sort of like trying to get Republicans and Democrats to agree on anything). The reason I like using ProfitSource for this purpose is that – for better or worse – it has an objective built-in algorithm for generating Elliott Wave counts. Bottom line, it is far less subjective than anything I would come up with on my own.
Figure 2 displays the current Elliott Wave counts for four currency ETFs – FXA (Australia), FXB (British Pound), FXC (Canadian Dollar) and FXE (Euro). As currencies (mostly) trade inversely to the U.S. dollar, it's interesting to note that all four of these recently generated “Wave 4 Buy” signals.
Courtesy ProfitSource by HUBB
As FXE is the most heavily traded – both in terms of shares and options – let’s take a closer look as shown in Figure 3.
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Courtesy ProfitSource by HUBB
As you can see – again, for better or worse – the ProfitSource wave count is projecting a move to the 118.78 to 124.40 range for ticker FXE between now and March 2018. IMPORTANT NOTE: I find these kinds of projections to be very enticing. But remember, they are in fact nothing more than projections and NOT guarantees. Bottom line: acting on an Elliott Wave projection requires something of a leap of faith and involves the assumption of speculative risk.
h3 Example Trade/h3Once again, what follows is NOT a recommendation, only an example. Let’s assume one wants to speculate on a rise in ticker FXE. In Figure 4 we see that the implied volatility for options on FXE is towards the low end of the historical range.
Courtesy OptionsAnalysis.com
This tells us two things:
- The amount of time premium currently built into FXE option prices is low
- One might be able to profit from an increase in IV
The example trade is known as a 'Call Backspread and involves:
- Buying 2 Mar2018 FXE 115 calls @ 1.47
- Selling 1 Mar2018 FXE 113 calls @ 2.46
Courtesy OptionsAnalysis.com
Courtesy OptionsAnalysis.com
As you can see in Figures 5 and 6:
- The cost to enter this trade – and the maximum risk – is $248. However, a loss of -$248 would only occur if the trade is held until March expiration and FXE close that day at exactly $115 a share (i.e., we can eliminate the risk of a maximum loss simply by planning to exit the position prior to expiration).
- If FXE falls apart and collapses in price then the risk is only about -$55.
- If FXE rallies into the Elliott Wave projection range of 118.78 to 124.40 then the anticipated profit would be somewhere between +$150 and +$750, depending on how soon the move occurs and how high the price goes (sooner and higher are better).
One last item: if by chance implied volatility increases, this could inflate the profit potential for this trade.
h3 Summary/h3Is the U.S. dollar going to decline, and/or will FXE rise? That I can’t predict, but for what it's worth, the current Elliott Wave projections are pointing in that direction. The example trade discussed here is just one of many potential ways to play such a move.
This blog DOES NOT offer investment advice. I just tell you what I know (or more accurately – what I think I know) or what I see and sometimes offer examples of ways to trade said items.
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