- Options remain the best way to trade jumpy EURUSD
- AUDUSD could surhe in the short term before downtrend resumes
- Kiwi outperforming post-'hawkish cut', but outlook remains bearish
- EURSEK highly valued post-ECB disappointment
It's now or... later, Ms. Yellen. Photo: Wikimedia Commons
By John J Hardy
Next week is a particularly tough week to contemplate for FX traders as we have the confluence of a couple of critical influences on the market that may prove extremely difficult for traders to navigate
First, there is the risk of position squaring/book closing/deleveraging/risk-off for the rest of the year after macro traders were burned by last week's European Central Bank meeting. Second, there is the much-anticipated Federal Open Market Committee meeting next Wednesday.
Both of these events present high risks of two-way volatility as they may represent conflicting influences on the market's direction in risky assets and currencies. So the key operating principle early in the week will be patience and limiting exposure, followed hopefully by traders being able to establish a firmer view in the wake of the FOMC.
Establishing EURUSD shorts through options
The near-term environment for EURUSD looks highly uncertain, with further risk of a squeeze higher driven by additional position squaring after last week's ECB catastrophe and/or if the Fed proves so cautious in its post-rate hike guidance that the USD comes under fresh pressure.
On the other hand, if the market decides there is still plenty of policy divergence to drive EURUSD lower and wants to be positioned for this into 2016, EURUSD could pivot quickly back lower. We look for a pivot, but we’re highly uncertain on the timing of this over coming weeks.
Trading stance: Short- to medium-term EURUSD bears may look to establish options structures to profit from the resumption of the bear market over the next one to two months, with on a partial position established before the FOMC.
Bears may want to keep considerable dry powder on the sidelines on the risk that the end-of-year and risk-off considerations combine with a more dovish than expected FOMC and drive EURUSD back into the 1.12-1.15 zone over the next few weeks before it resumes falling farther out.
Examples of downside options structure are long two-month 1.07500-1.0500 put spreads (buying the 1.0750 put and selling the 1.0500 put), which offer a reward-to-risk of slightly better than three-to-one if spot trades at or below 1.0500 at expiry (this was priced on Friday with EURUSD trading around 1.0965).
A more aggressive 1.0750-1.0600 one-month put spread costs around 31 pips and offers about 3.8 reward to risk, but requires that EURUSD falls more quickly.
Trading AUDUSD breaks
AUDUSD tantalised over the last couple of weeks by grazing the critical resistance areas around 0.7375 that look like the neckline of a head-and-shoulders formation. The technical situation is very much caught in limbo and we would prefer to let the market prove what it wants to do before trading the pair.
Our longer term outlook is to the downside, but a rally through the 0.7375/0.7400 area would be a compelling technical break to the upside, especially if we have a scenario in which we see the FOMC meeting surprising on the dovish side together with a strong jump in the higher yielding/riskier currencies.
Trading stance: Bears will look at shorting opportunities below 0.7150 on the other side of the FOMC meeting next Wednesday (targeting below 0.7000) while bulls will look buy on closes above 0.7375/0.7400 for tests above 0.7500.
Short NZDUSD through options/on downside break of support
The kiwi has been outperforming again after the Reserve Bank of New Zealand theoretically pulled off a “hawkish cut” in which it cut rates but kept guidance relatively optimistic, suggesting less likelihood of further rate hikes to come.
Next week we have NZ GDP data and the coming weeks offer high odds of the RBNZ strongly leaning against the recent, steep exchange rate appreciation if it continues. As well, the kiwi has been far too resilient given the ugly developments seen in risky assets globally over the last couple of weeks, and further pressure on risky assets usually punishes higher yielding/less liquid currencies – recall the kiwi's summer meltdown.
So this trade is a way for traders to have a call option on fear even if the other themes don’t lean against the kiwi’s favour in the nearest term. On the USD side of this trade, if the Fed proves more hawkish than expected, NZDUSD could come under pressure again.
Trading stance: Bears have a clear-cut case for shorting NZDUSD on a fresh move through the 0.6600 area of support, but ahead of this one might look to establish half of a bearish NZD trade by buying a put option with expiry, perhaps on January 29, for around 80 pips (priced on Friday with spot trading 0.6735) which lies on the other side of the January 19 Q4 NZ CPI report and the January 27 RBNZ meeting.
EURSEK selling opportunities after the Riksbank
EURSEK has been one of the more reluctant euro pairs to rally in the wake of the ECB disappointment, suggesting that the pair is richly valued.
This week’s Swedish CPI disappointment saw the SEK weaken a bit, but is not likely to be enough for the Riksbank to toll the alarm bell at next Tuesday’s meeting.
Trading stance: This is not a trading theme if markets are in full risk-off mode next week, but if the Riksbank fails to bring new policy measures to the table on Tuesday, traders may look to sell EURSEK for a break below the recent 9.20/9.18 area support over the next week or two.
Have markets priced in more hawkishness than a cautious Fed can muster? Photo: iStock
— Edited by Michael McKenna