Taper or not, The Aussie is Overvalued – How to play it
By: Chris Tell at capitalistexploits.at
We've always been fond of identifying and positioning for macro trends. Getting on board a bull market and riding that sucker for the majority of the move is more than common sense, it's profitable and as a capitalist it's our honour-bound duty to participate.
One currency that we've spoken about in these pages previously is the Australian dollar, or AUD for short. For a host of reasons it's one of the most overvalued of the fiat currencies in our humble opinion. Anyone who has been to Australia in the last few years knows of what we speak!
Although still trading too high, it has been coming back down to earth since it peaked at 1.12 to the USD in May. That downtrend was recently broken by our friend, Ben Bernanke.
First the Fed was tapering, then it wasn't tapering. By now we're all getting used to the "smoke and mirrors" economy. It's a trader's dream...the volatility that is. Suffice it to say the AUD has rallied on the new “non tapering” news. This allows us the opportunity to reposition.
Identifying an opportunity is one thing, but executing on the idea prudently and correctly, and managing one's risk is another.
We've had some successes trading, but find it extremely time consuming and stressful. As such, we've come more than once to rely on bouncing ideas off of successful friends - guys who live and breathe trading 24/7.
Our friend Brad Thomas is one such individual. Brad's a veteran of the markets, trades for a living and is often our first and often our only port of call when considering a trade in almost any market.
Brad agrees with our opinion that the AUD is headed lower, and he provided us with a way to play it, which is detailed below for the traders among you.
Macro View: Bearish outlook on AUD
Timeframe: short term (2 months)
Thesis: The AUD is in a primary down trend. The move from 89 to 95 over the last month has been sufficient to work off an oversold position, with many poorly-financed, leveraged bearish positions having been rooted out of the market. With this in mind, the AUD is now positioned to resume the downward trend.
Application: Create a bear put (vertical) spread on the FXA (Aussie dollar ETF). The bear put spread is necessary due to the relatively high level of implied volatility on the options. The spread offsets this volatility. If volatility was low then a plain vanilla put would be appropriate.
Trade: Buy 1 Nov '13 94 strike put, sell 1 Nov '13 89 strike put @ 1.0. )Always buy and sell an equal number of the option in this strategy).
- Cost & Max loss = $100
- Maximum payoff = $400, or 400%
- Breakeven = 93 (a premium of 1.6%)
Strategy: Hold until expiry, 18th October 2013
Risk Allocation: 1% of trading capital
All the FXA (AUD) needs to do is to fall by 1.6% (to the 93 level) over the next two months and the trade will at least break even.
A 100% return will be achieved if the FXA closes @ 92 at expiry. A maximum profit will be achieved (400%) if FXA closes at or below 0.89 @ expiry.
Below is how the trade would appear on the Interactive Brokers web platform (other platforms may or may not be similar):
The AUD's recent gains are simply working off an oversold position, and Brad believes this trend is reversing, as do we, and the macro trend will soon reassert itself. As such, this is an opportune time to position a trade such as the one Brad suggests.
The RBA (Australia's reserve bank) will meet next week, and we believe it's highly unlikely they cut rates further. They are already at 2.5%, so their room to move is not great.
Of course this is increasingly the case across the world as ZIRP bears down on all central banks. All of this is stemming from the broken economies of Europe, the US and Japan.
It makes a lot of sense to take advantage of the volatility created by the central bankers, especially if you are a trader by nature. Trade around the volatility while keeping a strong eye on the long term trends, and add to those positions that offer an asymmetric setup. This is in large part Brad's strategy, and it's definitely one we completely concur with.
“The key to trading success is emotional discipline. If intelligence were the key, there would be a lot more people making money trading… I know this will sound like a cliche, but the single most important reason that people lose money in the financial markets is that they don’t cut their losses short.” - Victor Sperandeo (master trader)
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