The biggest threat I see to this bull market is a strengthening US dollar. In some ways it’ll be good for us since a stronger dollar will drive down oil prices and slow inflation (in theory). In more direct ways it’ll reduce profits of US companies with a strong overseas presence. It will lower the cost of materials that go into products made here, but will hurt exporters. There’s a winner and a loser for either direction the dollar takes, but what we’ve seen a lot of for a while is an inverse relationship between the dollar and the S&P 500.
To try to profit from this potential strengthening of the dollar (as the European Union comes unraveled and QE2 ends) I turned to UUP (an ETF that attempts to track the Deutsche Bank Long US Dollar Futures index) options to see what might work best for me. My first instinct was to buy a call to leave my upside wide open while keeping my potential losses fairly low. The UUP December 21 calls are trading around $1.15 today as UUP is down to $21.69 as I write this. I thought about buying four of these contracts. With only $0.46 in extrinsic value the risk is fairly low. If UUP goes up I’d start to profit after another 2% gain in the dollar. If it goes down the most I could lose would be $460 ($1.15 x 400). If it got back up to $23, which certainly seems attainable, I’d make $340. UUP at $24 would give me a profit of $740. A gain bigger than that is possible, but the probability starts dropping pretty fast.
To try to increase my probability of making a profit I turned to vertical call spreads, but fairly soon reverted back to put spreads since the downside risk could be capped much lower. I tried this trade at the end of the trading day yesterday for $0.75, but it didn’t hit. This morning I re-entered my limit order and lowered my asking price for the put spread by a penny. I ended up having to lower it again for it to finally hit. While UUP was trading at $21.78 I bought 10 UUP September $22 puts for $0.72 each and at the same time sold 10 UUP September $23 puts for $1.42 each and received $705.55 after commissions. (That was a gross $0.72 premium for anyone who doesn’t want to do the math.) This is a fairly aggressive play considering both legs are in the money, but that’s why the upside potential is so great. I’m only risking $294.45 and have the potential of walking away with a gain of $705.55. If it works it’ll be a gain of 239%. If UUP doesn’t climb more than 1% I’ll have a 100% loss. If UUP heads lower I might end up taking the option assignment from my short puts and selling my long puts for a profit. I’d only do that if I really felt strongly about the dollar’s prospects from there. Having over $22,000 invested in one position might be more risk than I need to take on. I need another 5.5% gain from UUP to make a full profit. That’s where it was as recently as January, so I’m not asking too much of the green back.
UUP’s price is based on six other currencies (see table). Most of my theory is based on the euro and British pound’s decline. I expect the Japanese yen doesn’t have too good a chance of strengthening from here either as they rebuild post tsunami. Those three currencies make up more than 70% of UUP’s price so I have a think I have a decent shot at making this risky trade work.
The Street.com had a bullish article on UUP recently too. Click here to check it out.
Nice trade with very little risk. Obviously not something I personally would be interested in – being based in Europe with most of my investments in the US, I already benefit by a strengthening dollar (although, as you say, when the dollar rises, the stocks usually go down making me almost even). It’s definately a trade I’d consider if I was based in the US though.
I made no trades today. It looks like I was a bit too early to the party with CSCO, MSFT and NUE. The dividend should provide a decent floor to NUE and MSFT and, judging by the amount of cash in CSCO’s balance sheet, it should be pretty near a bottom.
The rest of my positions are looking okay but I think I’ll sit tight for another week or so and then get started on some July Options. I’d like to get back into VOD, VZ or T again and sell OTM Calls whilst collecting the dividend – but we’ll see how things play out next week.
Two new trades for me today. I bought another 300 shares of KCG doubling up my position to 600 shares – a full position at a basis of $12.37. I also sold a June 55 ITRI Covered Call at $0.65.
I also had an order in to sell MSFT Covered Calls but it didn’t hit. Hopefully, MSFT rises a little more tomorrow and I can sell these.