Friday, July 3rd, 2020

Trading Options on the US Dollar


With the US dollar stronger than any time in the last decade, trading options on the US dollar could be profitable. Ideally one would have purchased puts on the USD with Euros in the middle of 2014 when one Euro was worth $1.40. Considering that today the Euro is approaching parity with the dollar it would have been a profitable trade. But if you are trading options on the US dollar today do you trade dollars versus Euros or versus a minor currency such as the Colombian peso? And are you looking for the dollar to rise even farther or fall?

US Interest Rates

If you are going to buy foreign currency options what are the factors that you need to be aware of? Front and center is the issue of interest rates. A country with a high interest rate on government bonds tends to attract Forex capital and the value of the currency rises. And when a country starts to print money to stimulate its economy such as is happening in Europe its currency goes down. The combination of a projected increase in US interest rates and the European Central Bank quantitative easing program threaten to drive the dollar higher and Euro lower. In trading options on the US dollar versus the Euro most are betting that the Euro will continue to fall and the dollar will continue to rise.

The Price of Oil

If you are interested in trading options on the US dollar versus the Colombian peso you want to keep track of the price of crude oil. Oil is the biggest export of the South American country of Colombia and virtually all of it goes to the USA. When oil was trading at more than $100 a barrel in July of 2014 a dollar purchased $1,800 Colombian pesos. Now that a barrel of oil is hovering in the $50 to $60 range a US dollar is worth between 2,500 and 2,600 Colombian pesos. We wrote about oil options trading last December. A viable proxy for oil options trading is trading options on the US dollar with Colombian pesos!

How Long, How Far and When Is the Turnaround?

No currency rises or falls forever. The prospect of higher interest rates is driving the dollar up and a so-called competitive devaluation among central banks is driving down the value of the Yuan, Yen, Euro and more. These factors may drive the dollar higher but at some point things will turn around. Both fundamental and technical cues will likely be useful in helping decide when to switch from calls to puts on the dollar. And, when the market is especially volatile a simple strategy such as a long straddle may be useful. With a long straddle the options trader purchases both a put and a call on the same currency pair with the same options expiration date. The trader wins no matter whether the USD goes up or down and risk is limited to the prices of the call and put contracts.

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