New Trade: UUP and Away?

by CC March 16, 2012 2:38 pm • Commentary

With rates perking up, inflation entering the investor lexicon again, and the Fed & Co. potentially forced on hold as a result, we took a look at the UUP ETF options to see if there were any asymmetric opportunities to take advantage of a dollar rally in the next few months.

First off, UUP has the following composition:

So there is a high Euro component, but the recent decline in the Japanese Yen has bolstered the argument for using UUP for dollar exposure, as Europe has obvious issues, but now Japan and Switzerland are overtly targeting currency weakness. 

Alongside the blastoff in U.S. equities so far this year, the U.S. dollar has been quite resilient, down only 1% on the year.  This has occurred despite the fact that the negative correlation between the SPY and UUP is near the most extreme in recent history, nicely illustrated by this chart from

However, on the few down or flat days that the SPY has had this year, the UUP has exhibited large gains, and only small losses on the many up days in SPY.  As a result, there is a strong argument to made for further dollar strength on any equity market weakness, but there is a new argument being made for dollar strength based on U.S. comparative strength.

Options are a great way to play this potential paradigm shift.  Interestingly, UUP implied volatility has actually declined substantially in the past 3 months, while realized volatility has been more constant.  UUP implied volatility is almost at the same level as realized volatility, which it hasn’t often been over the last year:

[caption id="attachment_9683" align="aligncenter" width="582" caption="1 YR UUP HV30 vs IV30 from LiveVol Pro"][/caption]


So here’s the trade:

UUP (22.19) Buy the June 23 calls for $0.18. 


Looking at the 2 year weekly chart, UUP has had multiple $1-$1.5 moves in that period, and the low option premium level offers great risk-reward for the next 3 months as a result:

[caption id="attachment_9684" align="aligncenter" width="592" caption="2 year UUP from LiveVol Pro"][/caption]