Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
THE DOLLAR INDEX
The US Dollar Index seems to be overlooked. Are there opportunities there?
Yes! The US Dollar Index (DX) futures contract, traded on the Intercontinental Exchange (Ice), could be one of the most underrated futures products on the board. Let’s face it, traders are human and humans have an undeniable tendency to migrate toward the comfortable. Unfortunately, the dollar index is the oddball of the currency futures complex, simply because it doesn’t trade on the Cme Group with the others, and it carries different contract specifications. Nonetheless, it offers traders some attractive characteristics that can’t be found elsewhere, such as built-in diversity.
Unlike Cme Group–traded currency futures, which are all paired against the US dollar in “American terms” (foreign currencies priced in dollars), the DX future is the value of the US dollar against a basket of foreign currencies. As a result, this futures contract enables speculators to trade the value of the dollar, as opposed to against a specific currency. In addition, it can be used as an effective tool to hedge risk of changes in greenback valuation for those with international stock, bond, or commodity exposure.
I would also argue that the US Dollar Index futures contract might be an alternative to the highly volatile and treacherous metals complex. If you ask any gold or silver bull why it is they believe metals prices will appreciate, they will likely tell you that a devaluing dollar, assuming the trend continues, will force precious metals prices higher.
If the primary argument for owning metals is the declining dollar, it might be feasible to speculate on the short side of the greenback, as opposed to playing the long side in the overly dramatic silver and gold contracts. As many traders have abruptly learned the hard way, the metals markets can be treacherous in both directions. This isn’t to say that the DX doesn’t see volatility from time to time, but in my opinion the risk exposure in this diversified index is much less than owning positions in gold and silver.
For instance, in May 2011, silver futures fell nearly 30% in a matter of a few trading days after reaching a fresh multidecade high. The dollar index futures, on the other hand, rose about 4.5% in May over the course of about a week and a half. Rather than pushing your luck in metals, perhaps a more efficient and tamer trade could be to short the DX futures contract.
If you ask gold or silver bulls why they believe metals prices will appreciate, they will likely tell you a devaluing dollar will force prices higher.Of the dollar index futures contract, 57.6% is made up of the euro, and the second-largest represented currency is the yen at 13.6%. The remainder of the basket is made up of the British pound, the Canadian dollar, the Swedish krona, and the Swiss franc. Although the foreign currencies tend to be highly correlated in regard to their relationship to the US dollar, the inherent diversity built into the index works toward mitigating the overall volatility of the contract.
For example, in early 2011, there were times in which the euro and the yen futures (paired against the greenback) moved in the opposite direction. Similarly, even if they are moving together, some foreign currencies might only see moderate price changes, while others are experiencing much larger moves. The index itself eliminates some of the country-specific event risk and works toward smoothing out market volatility that might be exposed to traders choosing undiversified and highly emotional products such as gold and silver futures.
Along with being somewhat diversified and much tamer than gold or silver futures, the dollar index requires only a moderate amount of margin.
At the time of this writing, Ice requires traders holding overnight positions to have $1,197 on deposit (initial margin) and only $900 to maintain the position (maintenance margin). To put this into perspective, the initial margin on the standard-sized silver contract was $21,600 and gold was $6,750. Obviously, the dollar index futures contract doesn’t deliver the action-packed leverage traders get from the metals, but I’m not convinced that is a drawback. In my opinion, it is an advantage.
Simply put, out-of-control gains and losses delivered to metals traders often breeds chaotic decision-making and therefore could end in disaster. For instance, imagine the emotional roller-coaster experienced by someone who went long silver near $45 per ounce to quickly watch the market approach $50 (a gain of $25,000 per contact) and then, even more abruptly, watch futures plummet to under $34 in a few short days without any reprieve. Suddenly a $25,000 winner turns into a $55,000 loser.
Even those trading a single mini futures contract would have had a similar experience but in one-fifth the scale. A trade in the green by $5,000 would have become a trade in the red by $11,000. What’s so “mini” about that?