Since the start of QE and ZIRP, Don’t fight the Fed has been one of the most profitable consensus US equity trades of the last fifty years. In the last year, the Fed has ended QE, and is now expected to end ZIRP, if at least symbolically at their December FOMC meeting. With the end of their crisis monetary policy, another consensus trade has emerged, long the U.S. dollar vs almost every other major currency. And it’s not just that tighter monetary policy, coupled with a perceived strengthening of the U.S. economy means a stronger dollar, it’s also that most of the developed world’s central banks are easing monetary policy. The ECB is on deck with their next policy meeting on December 3rd, expected to at least speak to further easing, if not lay out more new programs.
Regular readers know that I don’t pretend to have any special knowledge when it comes to macro investing / trading, but if one of the biggest risks to U.S. corporate profits is a rising dollar, then it could make sense to look for a cheap way to offset the negative impact on your U.S. multinational equity holdings. One way to do this is with dollar cheap call options in the UUP, the PowerShares US Dollar etf. UUP is designed to replicate being long the US Dollar against the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc. The UUP is up 7.5% year to date, vs the U.S. Dollar Index (DXY) up about 10% and the USD is up about 14% vs the Euro alone.
Options in the UUP appear cheap because the underlying does not move a heck of a lot, in 2015 it has traded in a range of $24 to $26.50, and for the last 7 months it has traded even tighter, between $24.50 and $26:
Much of the ytd gains in the UUP has come since the FOMC’s October meeting, with the etf up almost 6%. The dollar bulls may pause as we head into the New Year as the Fed looks set to raise rates for the first time since June 2006. But like I said earlier, ECB head Mario Draghi is about to embark on more QE.
Options prices are not only cheap in dollar terms but also in relative volatility terms, with 30 day at the money implied vol just below 10%, while 30 day realized volatility, how much the underlying etf has moved at about 8.5%:
So What’s the Trade?
To play for a breakout the March 26 calls at .47 are dollar cheap and can be spread later if the etf goes above 26.
If you think that the UUP could be ready to breakout of this year long consolidation, but are hesitant in the wake of the recent run, you want to finance that March call. Here’s how we’re doing it:
*Trade: UUP ($25.90) Buy the Dec31st 26.5/ March 26 vertical call calendar for .35
- Sell 1 Dec 31st 26.50 call at .12
- Buy 1 March 26 call for .47
Rationale – Consensus is that the dollar continues higher but there are a lot of moving parts here as no one really expects to see an aggressive FOMC beyond 1 or 2 symbolic rate hikes. And UUP already reflects a lot of the news. So as with any breakout play you want to be careful, define your risk and look to finance as best you can. This won’t lose money on any serious move above the 26.50 strike (although the profits are capped if that move happens before year end). Ideally we want UUP to creep up near 26.50 by year end and then we have a few options how to roll and further reduce premium risk in March.