FX Options Sentiment Warns of USD Trend Change

07/22/2010 12:01 am EST

Focus: OPTIONS

A sharp correction in US dollar sentiment across FX options markets gives us clear pause in our USD-bearish bias, but especially choppy price action makes it difficult to determine whether this may be the start of a dollar reversal. Last week we plainly called for continued greenback losses as FX options traders placed aggressive bets on and hedges against USD weakness. Yet the more recent dollar correction leaves clear doubt, and it is admittedly difficult to forecast the next market moves. The next several weeks of price action will likely be pivotal in determining the trajectory of the US dollar.

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Euro/US Dollar Options Analysis


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A noteworthy pullback in the EUR/USD pair has been met with similarly sharp shifts in FX options risk reversals, clouding short-term outlook for the previously high-flying currency pair. Last week, we wrote that a major move towards euro buying across FX futures and options markets pointed to further gains. Yet extreme market choppiness has made short-term price moves especially difficult to time, and the sharp correction clouds our outlook. The previous months’ shift towards euro buying leaves our bias weakly bullish, but that could easily shift if FX options risk reversals show a further deterioration in sentiment.

NEXT: GBP/USD, USD/JPY, and More

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British Pound/US Dollar Options Analysis


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Our short-term trading bias for the GBP/USD pair is quite similar to that of the EUR/USD, as a noteworthy correction in FX options sentiment weakens our previously bullish bias for the GBP/USD. Our breakout-style trading system theoretically went long the pair as of June 14 as the one-week risk reversal hit its highest level in the previous 90 days. That same system would have closed that long position as of yesterday, July 20, as the percentile dropped below the 70% mark. Our bias is subsequently weakly bullish, but a further correction in risk reversals could make us bearish.

US Dollar/Japanese Yen Options Analysis


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Forex options market sentiment has been very inconsistent on the USD/JPY pair. Sharply choppy price action has led to similarly sharp swings in risk reversals, and such indecision gives few clues on what to expect next out of the USD/JPY. Forex futures markets show that non-commercial traders—most often speculative in nature—remain quite heavily net-short the US dollar against the Japanese yen. If nothing else, the risk of short covering gives us a very modestly bullish bias. Yet we would hardly place aggressive trades on any such hunches.

NEXT: USD/CAD, USD/CHF, and More

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US Dollar/Canadian Dollar Options Analysis


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Forex futures options sentiment on the USD/CAD has been quite choppy as of late, as sharply range-bound price action underlines trader indecision. Last week, we wrote that the sharp shift towards bets on and hedges against USD/CAD weakness (Canadian dollar strength) pointed to further declines, but a considerable correction has compromised said forecast. As it stands, it is difficult to establish a strong bias in the pair; both FX futures and options sentiment remain quite near neutral.

US Dollar/Swiss Franc Options Analysis


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Dramatic Swiss franc advances (USD/CHF declines) have left FX options risk reversals plainly in favor of further USD/CHF losses. Our benchmark breakout-style FX options risk reversals system would have gone short the USD/CHF as the one-week 25-delta risk reversal hit its lowest levels in the previous 90 days on June 14. Dramatic weakness leaves clear risk of short-term corrections, but it seems that the tide has turned in favor of continued CHF appreciation (USD/CHF declines).

NEXT: Article Concludes with Analysis of AUD/USD, USD/NZD

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Australian Dollar/US Dollar Options Analysis


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Our short-term bias for the AUD/USD pair is unclear as mixed sentiment and intensely choppy price action makes it difficult to establish any short of conviction in short-term forecasts. Just several weeks ago, we called for declines amidst a sharp shift towards bets on and hedges against further Australian dollar weakness. Yet a dramatic turnaround in the AUD/USD has pushed risk reversals significantly higher. If anything, the sharp shift towards bets on/hedges against AUD/USD strength leaves us in favor of short-term rallies. Yet we hesitate to switch direction after having previously called for aggressive declines.

New Zealand Dollar/US Dollar Options Analysis


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Extremely choppy price action in the NZD/USD pair is making short-term forecasts especially difficult. Two weeks ago, we wrote that a substantive shift towards bets on/hedges against NZD/USD weakness signaled further declines were likely. More recently those same risk reversals have bounced considerably from their lows. Given such market indecision, we will remain in “wait and see” mode on the NZD until further notice.

By David Rodriguez of DailyFx.com


DailyFX provides forex news on the economic reports and political events that influence the currency market

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