Currency fluctuations are driven by global economic strength or
weakness, and recently fear has increased demand for the safety of
U.S. dollars as growth in China and Europe has slowed. These
short-term crises have not, however, solved the larger negative
fundamentals of thegreenback .
The dollar has actually gained more than 10% since the lows in
2008 in the face of the Federal Reserve's printing proficiency. But
a dollar demise seems imminent, and the extremely low volatility in
the widely traded
PowerShares DB US DollarIndex Bullish (
UUP
)
exchange-traded fund (
ETF
) sets up an attractive options play.
UUP has traded quietly in a $2 range between $21 and $23 for
almost two years. A downside breakout of the trading range targets
a move to $19, which is 14% lower than current levels.
Rather than shorting the stock outright for a potential 14%
gain, traders who buy put options on UUP could make triple-digit
profits on a move to that level.
One major advantage of using put options rather than shorting
shares is putting up much less to control 100 shares -- that's the
power ofleverage . But with all of the potential strike
andexpiration combinations, choosing anoption can be a daunting
task.
Simply put, you want to buy a high-probability option that has
enough time to be right, so there are two rules traders should
follow:
Rule One: Choose an option with 70%-plus probability.
Delta is a measurement of how well an option follows the
movement in the underlying security. It is important to buy options
that pay off from a modest price move in the stock orETF rather
than those that only make money on the infrequent price
explosion.
Any trade has a 50/50 chance of success. Buyingin-the-money
options increases that probability. Delta also approximates the
odds that the optionwill bein the money at expiration. In-the-money
options are more expensive, but they're worth it, as your chances
of success are mathematically superior to buying cheap,
out-of-the-money options that rarely pay off.
For example, with UUP trading at about $22 at the time of this
writing, an in-the-money $23 strike put currently has $1 in real
orintrinsic value . The remainder of any premium is thetime value
of the option.
Rule Two: Buy more time until expiration than you may need -- at
least three to six months -- for the trade to develop.
Time is an investor's greatestasset when you have completely
limited the exposure risks. Traders often do not buy enough time
for the trade to achieve profitable results. Nothing is more
frustrating than being right about a move only after the option has
expired.
I recommend the UUP Jan 2014 23 Puts at $1.50 or less.
A loss of half of the options premium would trigger an exit. If
you do not use a stop, then the maximum loss is still limited to
the $150 or less paid per option contract. The upside, on the other
hand, is unlimited. And the January 2014 options give thebear trend
over a year to develop.
This trade breaks even at $21.50 ($23 strike minus $1.50 option
premium). That is about 50 cents below UUP's current price. If
shares hit the downside breakout target of $19, then the option
would deliver a gain of almost 170%.
Action to Take -->
Buy UUP Jan 2014 23 Puts at $1.50 or less. Set stop-loss at 75
cents. Set initialprice target at $4 for a potential 167% gain in
14 months.
This article originally appeared on TradingAuthority.com:
Dollar's Demise Could Make You Triple-Digit
Profits