U.S. dollar bulls have gleefully cheered on the downward spiral in the Japanese yen, the continued struggles of the euro and the nascent breakdown in the Aussie dollar. Simply put, the pervasive weakness in a broad swath of foreign currencies has bolstered the buck this week.
Remember, the greenback doesn’t trade in a vacuum rising and falling solely based on the merits of the U.S. economy. Instead, its value will fluctuate relative to the value of other currencies.
Picture the buck sitting on one side of a teeter-totter and a basket of foreign currencies sitting on the other side. A drop in the value of the basket inevitably leads to a rise in the U.S. dollar, and vice versa. We’ve seen just such a dynamic play out over the past week.
Further bolstering the resolve of dollar bulls is the increased anticipation of the eventual end of quantitative easing by the Fed. What’s more (bullish for the buck, that is), the heightened speculation of the Fed tightening comes at a time when central banks across the globe are cutting interest rates.
Click to Enlarge Macro and fundamental arguments aside, the technical view of the buck has improved considerably in recent years. Since bottoming in 2008, the U.S. Dollar Index has entered a multiyear consolidation phase which might well act as a base for its eventual ascent. The formation of a higher pivot low in 2011 and earlier in 2013 reveal the increased aggressiveness of dip-buyers.
Click to Enlarge The next chart provides a more detailed view using the Powershares US Dollar Index Fund (NYSE:UUP).
Since the 2011 low, UUP has respected its rising trendline (green dotted line). With last week’s surge in the dollar, UUP is now testing intermediate-term resistance in the $22.70 zone. A successful breakout of this level could lead to an eventual test of its 2012 highs at $23.15.
Traders looking for a way to exploit higher prices in the U.S. dollar could purchase call options on UUP. Because it will take time for the bullish thesis to play out, though, it’s important to buy enough time.
Consider buying the Dec 21 calls for $1.72 or better. The max risk is limited to the initial $1.72 paid and the max reward is unlimited. The beauty of the play is that you really only need UUP to rise about 5 cents from its current price by December to break even. Anything above that is pure profit.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.