Forex Options Point to a Slowdown in US Dollar Gains

Forex options and Futures markets continue to show that US Dollar sentiment is at bearish extremes, and a further unwind of said positioning is likely to produce material US Dollar rallies. Indeed, we have been calling for a major Dollar turnaround for quite some time now.

Forex options and Futures markets continue to show that US Dollar sentiment is at bearish extremes, and a further unwind of said positioning is likely to produce material US Dollar rallies. Indeed, we have been calling for a major Dollar turnaround for quite some time now. It is never good to be early on calls for a trend reversal, but we feel that dynamics are such that Dollar strength is likely to continue. Elevated forex options market volatility expectations virtually guarantee eventful price action in the week ahead.

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Volatility expectations have surged across the board on the recent US Dollar turnaround. Typically we see major market turns on especially fast-moving price action, and this likewise hints at further dollar gains. Of course, sky-high FX options implied volatility levels likewise guarantee that price will not move in a straight line. We advise caution in setting maximum risk levels for trading on what looks to be one of the most eventful weeks of price action for the better part of a year.

Euro/US Dollar Options Analysis

Futures positioning on the Euro/US dollar has unsurprisingly moderated as of late, as traders begin to close their extremely net-long positioning on EURUSD tumbles. FX options risk reversals likewise show that many are hedging against further Euro weakness, and the sharp shift actually suggests we are growing near a short-term bearish sentiment extreme. We remain bearish the EUR/USD on the prospect of further position covering, but risk of bounce is high.

British Pound/US Dollar Options Analysis

FX Options and Futures sentiment continues to suggest the British Pound may outperform the Euro on comparatively neutral positioning. Non-commercial traders actually remain fairly heavily net-short GBPUSD—as they have been since it last traded above 2.0. FX Options risk reversals are decidedly neutral the currency pair, and our short-term outlook is somewhat mixed. Suffice it to say, however, a further unwind of FX Futures positioning would produce GBP strength.

US Dollar/Japanese Yen Options Analysis

Forex options markets show that traders are the most bullish the USDJPY (Bearish the Japanese Yen) in the past 90 trading days, while the longer-term trend in price shows we are in a fairly clear downtrend. The FX options market sentiment extremes suggest that we may have hit a USDJPY top and it is likely to continue its longer-term correction. A sharp correction in Non-Commercial futures positioning leaves scope for further USDJPY weakness.

US Dollar/Canadian Dollar Options Analysis

We have persistently called for Canadian Dollar weakness against the US Dollar (USDCAD strength), but a sharp shift in sentiment suggest the pace of gains may slow. Non-Commercial futures positioning had reached the most USDCAD-bearish (Canadian Dollar bullish) extremes since the pair traded near parity. We have seen futures positioning pull back somewhat, but the bigger story is FX options risk reversals. The sharp shift signals that USDCAD gains may slow.

US Dollar/Swiss Franc Options Analysis

Non-Commercial futures positioning on the US Dollar/Swiss Franc pair remains the most bearish in nearly 5 years—pointing to clear sentiment extremes. Yet FX Options actually show that risk reversals are at bullish extremes and give a decidedly mixed view on the Swiss Franc. All else remaining equal, we expect that an unwind of USDCHF shorts (Swiss Franc longs) will produce rallies. Yet the sharp shift in Risk Reversals suggests that the pace of gains will slow.

Australian Dollar/US Dollar Options Analysis

We continue to call for a sustained Australian dollar pullback, as sentiment has remained extreme for quite some time now. Non-commercial futures traders remain near the most net-long the AUDUSD since the pair traded above 0.90. As with other US Dollar pairs, however, FX options show a substantive shift in market sentiment. The impressive drop in risk reversals suggest that the pace of AUDUSD losses may slow, but we remain bearish on a medium-term basis.

New Zealand Dollar/US Dollar Options Analysis

The New Zealand dollar/US Dollar pair is quite similar to the AUDUSD, with significant sentiment extremes leaving the door open for near-term declines. As of several weeks ago, Net Non-Commercial positioning on NZDUSD futures remained the most net-long since the pair set noteworthy tops in July, 2007.

Written by David Rodríguez, Quantitative Strategist for DailyFX.com, drodriguez@dailyfx.com