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Trading Lessons

Crisis Currencies Poised to Surge as Frightened Capital Flows from Risk to Safety

Currencies / Forex Trading Jul 27, 2008 - 05:18 PM GMT

By: Money_and_Markets

Currencies

Best Financial Markets Analysis ArticleJack Crooks writes: On various occasions in the past couple months, my editorial has tried to bring to light some of the bright spots, or shall I say "relatively less dark spots", in the U.S. economy.

Ultimately, I've tried to connect it to the dollar and its potential to temporarily buck (pun intended) its long-term bearish trend. Sometimes I've had it right, for a little while anyway, and other times I've had it wrong, or at least the market told me I did.


Some of those times, actually probably most of those times, dollar-bearishness was warranted. But other times, when economic time-bombs were going off in areas outside the U.S., dollar strength was probably warranted.

Taking into account the relatively burnt out condition of the U.S. dollar, now is certainly one of those "other" times.

The only question: Is the consensus ready to call off some of the dogs and sic 'em on the euro ... the pound ... or maybe even the commodity dollars (ComDols)?

And what about the crisis currencies like the Japanese yen and the Swiss franc?

A Bad Month for European Economies

Just this morning we learned that the economic drip in the Eurozone and U.K. is turning into more of a stream of bad news. Here are some major bullet points:

Eurozone Manufacturing
  • Optimism concerning Eurozone manufacturing and services activity declined to its lowest level in 10 years.
  • The services component of the Eurozone Purchasing Managers' Index slumped from 49.1 in June to 48.3 in July.
  • The manufacturing component of the Eurozone Purchasing Managers' Index sank from 49.2 in June to 47.5 in July.
  • The German Ifo business climate index fell from 101.3 last month to 97.7 this month, its lowest level in three years,
  • Business confidence in France also fell to its lowest level in three years.
  • Business confidence in Italy fell to its lowest level in seven years.
  • Retail Sales in the U.K. dropped 3.9% — the most in 22 years.

The numbers may not impact U.S. investors directly, but they have a huge bearing on the currency market.

With European manufacturing and services activity declining and business confidence and retail sales also slumping, the time is right to consider trading options on foreign exchange.
With European manufacturing and services activity declining and business confidence and retail sales also slumping, the time is right to consider trading options on foreign exchange.

With such obvious signs of economic deterioration in European and U.K. economies, their respective central bank monetary policy is called into question. In other words, the need to hike interest rates is wiped clean off the table, and the potential to cut rates is penciled in.

And for good measure, the Reserve Bank of New Zealand (RBNZ) started cutting its interest rate earlier this week. They knocked off 25-basis points to bring their benchmark rate down to a still lofty 8%. To which I ask:

Will the RBNZ be a trend-setter for other global central banks that might be "behind the curve?"

We shall see, but it's not looking good for the ECB and BOE inflation fight.

And with a week of dollar strength in the books, be prepared for a major sentiment shift in the currency market. Meanwhile, however ...

 

The Crisis Currencies Are Poised to Surge

As the credit crisis and economic woes deepen in the U.S. and spread both West and East, massive amounts of frightened capital is likely to flow from risk to safety; from the weakening currencies to crisis currencies.

And there's no question as to which are the world's paramount crisis currencies: The Swiss franc and the Japanese yen.

These two currencies were the great beneficiaries during the Crash of '87, the Debt Crisis of 1998 and again during the current credit crisis, enjoying sweeping and massive upward moves.

This is well known, proven, historic fact.

What most people do not seem to realize, however, is the fact that this is not strictly a trans-Atlantic capital flight (out of the U.S. dollar)! Investors that are rushing out of the British pound and the commodity currencies ALSO seek safer havens like the Swiss franc and the Japanese yen.

You may not see this if you look at the currency market myopically. You may even see the crisis currencies decline temporarily in sympathy with the euro. But the big picture is clear: In times of crisis, these currencies shine.

And if you're looking for a tool to help position yourself for these trends, I urge you to consider ...

Trading Options on Foreign Exchange: The Best of Both Worlds

There are several ways to play currencies nowadays. The spot and futures markets offer maximum leverage — a trader's playground; ETFs and currency CDs offer slow and steady investing — perfect for buy-and-hold types; Options on currencies make up an alluring balance of the two.

Options have long been praised for their massive upside return potential, while strictly limiting risk to the size of your investment ... and not a penny more. That means you can't lose more money than you initially pay to purchase an option, AND you still have the ability to double and triple the money you put down.

Currency options aren't entirely fresh to the forex scene. Informed market players big and small have had access to them for years. But now, there's a new and easier way to gain foreign exchange exposure via options.

Just one year ago the Philadelphia Stock Exchange unveiled its World Currency Options .

In other words, they opened up a whole new world to traders and investors once intimidated by foreign exchange. World Currency Options offer all the benefits of options — significant leverage and strictly limited risk — while allowing access through a standard equities brokerage account.

Basically, you can trade these options just like you would any option on any U.S.-listed stock. No forex account and no futures account necessary.

Things to Know Before You Go ...

In dealing with these options I recommend you only take the long side when opening a position. That means you'd be buying put options or call options. You'd only be selling put options or call options when exiting a position.

Even with this guideline, you can still ...

1. Be profitable no matter if prices are rising or falling. In other words, you're able to make money on any currency that's falling (by purchasing put options) just as easily as if it were climbing (by purchasing call options).

2. If you've been buying call options on the euro over the last couple months, chances are you've been raking in the dough. This week, however, things are looking up for the buck, and you may want to consider put options ... whether just for the near-term or over the next several months.

And if you're wondering what other currencies you've got to choose from, you can ...

3. Buy calls AND puts on ANY of the six majors:

Euro
British pound
Japanese yen
Swiss franc
Australian dollar
Canadian dollar

That's going to give you plenty of flexibility, regardless of how the U.S. dollar is behaving. And what's more, you can ...

4. Control a whole bunch of a currency, with a relatively small amount of capital. That's what we call leverage, and that's how currency options can deliver hefty returns in a fairly limited amount of time. How about an example ...

The Australian dollar is currently trading around $0.9570.

Each options contract on the Australian dollar, be it a put or a call, controls 10,000 Australian dollars — or US$9,570.

If you were to buy one in-the-money put option that's about three months until expiration, at current prices you'd be able to control those 10,000 Australian dollars with only $252. And if you wanted to buy five in-the-money put options that are about three months until expiration, at current prices you'd be able to control 50,000 Australian dollars with only a $1,260 investment.

With currency options, you can take part in price movements without having to fork over a large amount of funds. And that's one heck of an opportunity to pursue big-time gains while limiting your risk to only the money you throw out on the table.

Best wishes,

Jack

This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com .

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