**Note to readers...We spoke about the U.S. dollar and UUP trade in a Hot Topic yesterday. A few subscribers wrote in asking for more commentary on the topic, so the trade will look similar. Thank you for the feedback, please keep the constructive comments and ideas coming our way. The OptionsProfits team.
There is no argument that the U.S. dollar is an important monetary vehicle in the world today. Even with our current problems, there is something about a U.S. denominated piece of paper currency that brings a confident smile to people's faces. Especially overseas. Recently, I was in Seoul, South Korea working with a proprietary trading firm. During a break I went out to buy some jewelry for the wife (FYI -- never forgot to buy jewelry for the wife when you are gone for more than seven days). No matter if I pulled out a healthy stack of South Korean won or an American Express Centurion card, everyone paused, cleared their throats nervously and asked, "Excuse me, do you have any U.S. Dollars?" I did. I forked them over. And they were pleased.
Everyone knows how important the U.S. dollar is in the current market equation. While the oddity of bonds, gold & the S&P 500 all grinding higher over the past few weeks may be starting to break down, the dollar has been the leading indicator of this market for some time. As the dollar moves lower, stocks move higher. Nothing else has mattered. Simple as that. The dollar is THE power in the world today. Ignore its price movement at your own peril.
We have been losing our downward momentum in the U.S. Dollar Index (DXY) and have started to find support around the $77.00 area. If our long squeeze fires off, we could easily get a 61.8% retracement of our previous swing low into the $80.70 range. This would cause many things to happen. First, of course, the euro would fall and retrace some of its monstrous gain over the past few months. Next, and more importantly, stocks would fall and they would fall hard. Not permanently mind you. Sure, financial pundits would come on TV and start talking about "double-dip recessions" because, after all, that is the only thing to talk about if stocks are headed lower. But, that would have nothing to do with the sell off. Once the dollar finishes its dead cat bounce and rolls over, stocks will rally and the financial pundits will claim that the economy is "picking up steam." Sigh.
Technically, we are setting up for a "sell the news" selloff right after the election. In reality, what we are setting up for is renewed confidence in the U.S. dollar after the election. Massive change tends to do that, if only temporarily. This would push the dollar higher and would punish stock prices. So what is the best way to take advantage of this potential rise in the dollar and break in stocks? I will be using the November call options in the PowerShares DB USD Index Bullish ETF (UUP) - Get Report (a trader could also use November put options in SPDR S&P 500 ETF (SPY) - Get Report). The UUP will rise as the dollar rises and since the spreads are tight and prices are low, you can adjust your risk to match what you might risk in a higher priced stock. I try not to think in the number of contracts per trade, but the total risk. So if you're only risking 3% of your account on each trade determine your dollar figure risk, then find how many contracts you can buy and stay within that risk instead of just buying five or 10 contracts regardless of the stock price.
Finally, always remember my favorite trading adage as it has kept me alive over the past two decades worth of trading. "Discipline Before Vision". No matter what vision you have for the markets heading into the future (vision) always establish your stop loss point (discipline) on the off chance you might be wrong.
Trade: Buy to open UUP November 22 calls for $0.55.
At the time of publication, John Carter held no positions in the stocks or positions mentioned.
John is a Commodity Trading Advisor with Razor Trading. McGraw Hill commissioned him to write a book entitled Mastering the Trade, which was released in January 2006. Carter has also been featured on ABC Money. He and Hubert Senters founded and run the Trade the Markets web site.
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