Long US Dollar with Affordable Option Spreads

Here is an alternative long US dollar suggestion. 

Consider looking at the CurrencyShares Euro Trust (FXE) 147.20 using a bear put spread as an alternative to a bull call spread on the PowerShares DB US Dollar Index Bullish (UUP) 23.94.

The FXE options currently trade about 7 times the volume with 18 times the open interest compared to the UUP.   This added liquidity means it is easier to get the spread trades completed with less slippage between the bid and offer prices and hopefully this will translate into a lower net debit for the position. Since these two ETFs appear to be mirror and inverse images the added liquidity should help minimize transaction costs without diminishing the direction effect.  

With a current Historical Volatility of 9.70 consider this alternative strategy for the higher US Dollar. 

• Buy FXE Dec 145 put FXEXO 3.10 IV 11.86 Delta -.4269
• Sell FXE Dec 140 put FXEXJ   1.325 IV 11.73 Delta .2330  

Debit 1.775 Position net delta -.1939

One of the advantages of using spread options, either calls or puts is that they are based upon the difference between the two strike prices. This means a position can be taken in a high priced underlying stock or index without proportionately increasing the cost of the spread. Therefore the cost of a spread on a $40 stock could be no more expensive that a similar spread on a $400 stock. The advantages of using a spread in these circumstances should be obvious.

For example, last week we suggested looking at a bull call spread using PowerShares DB US Dollar Index Bullish (UUP) 23.94. The debit was 1.35, which means a one contract cost is $135 dollars. 

Now we suggest looking a similar position that is a bear put spread using CurrencyShares Euro Trust (FXE) 147.20. Notice that although the cost of the underlying ETF is 6 time more expensive, the debit is only 1.775, or $177.75 for one contract.

Another advantage of using spreads is for minimizing the risks of changing volatility and time decay associated with a single options position.   Since we are long one option and short the other the loss (or gain) due to changes in both volatility and time decay are offset. In addition, the risk is defined and limited to the initial debit cost.

In summary, a properly structured spread allows us to take positions in high cost underlying stocks or ETFs for a limited modest and defined cost with neutralized volatility risk and time decay concerns.     

Disclosure: I do not have any positions in either UUP or FXE currently.

Comments

[kkin365:]

Volume is truly an important consideration. The put spread is interesting; being a novice, I need to study it. What are risks of being assigned? Or is this settled without transfer of securities?

2008 Sep 02 09:40 AM