Long Dollar Suggestion: Low Cost, Limited Risk

For the third week, the US Dollar Index Cash  [DXY0] 76.81 [ICEUS] is in the macroeconomic and financial markets spotlight.  

The rapidly rising US Dollar Index reflects the perception of economic weakness spreading to the major trading countries and the narrowing of the US trade deficit from declining imports and improving exports, that will cause an upward revision in the second quarter GDP growth rate. 

On a relative basis, the US seems to be doing better that some of our trading partners and with the now declining cost of crude oil the US could recover faster. If the European Central Bank [ECB] lowers interest rates to support the euro area economy the interest rate differential will be reduced giving further support to the dollar. For now the momentum is with the dollar as it has climbed out of the July 15, 2008 depths of despair at 71.77.

Consider this low cost position with a limited and defined risk to get long the US Dollar.

PowerShares DB US Dollar Index Bullish (UUP) 23.93. The gap down on Thursday August 21, 2008 appeared to be the start of a correction but was short lived with a gap back up on Friday August 22, 2008.  We think there could be more of a correction to come but the reversal back up on Friday is noteworthy and makes us want to increase our positions.

With a Current Historical Volatility of the ETF at 8.37, look at this bull call spread idea.

• Buy UUP Dec 22 ½ call UUPLX 1.85 IV 17.36   Delta .7589
• Sell UUP Dec 25 call UUPLE  .50 IV 16.35   Delta -.3505

Debit 1.35   Position net delta .4084

The value of the spread is limited to the difference between the two strike prices, for this position it is 2 ½.  If the dollar strength continues until the end of the year this position would almost double in value.  With a defined and limited risk of the 1.35 debit and because we are long one option and short the other we offset and neutralize the volatility and time decay risk associated with an individual option position. Since the current correction may continue for awhile longer, we suggest using these longer dated December options to allow sufficient time for the expected correction to be completed. 

While UUP is trading with reasonable volume, the options have only been trading since late June and are still fairly thin.  Be careful with order entry, use a spread order and adjust the spread price for the next day trading in the ETF by using the position net delta above.

Disclosure: I currently have no positions in the UUP ETF.

Comments

[User 30121:]

I can't believe you haven't been swamped with "What the hell are you talking about...." comments. So, here it goes: What the hell are you talking about. Have you been living in a cave the past five years?

In keeping this brief, you go buy USD long. But before you do, give your heirs an opportunity to have you committed!

2008 Aug 25 08:51 PM

[Ebi:]

Saving Fannie and Freddie will cost tax payers and deteriorate the financial position of the US govt. This is just a mini rally.

2008 Aug 27 07:26 AM