Explore Your Options
| Got a question about options? Tom Gentile is the chief options strategist at Optionetics (www.optionetics.com), an education and publishing firm dedicated to teaching investors how to minimize their risk while maximizing profits using options. To submit a question, post it on the STOCKS & COMMODITIES website Message-Boards. Answers will be posted there, and selected questions will appear in future issues of S&C. |
Tom Gentile of Optionetics |
DOLLAR BOUNCE
The US dollar has performed miserably against the euro in recent years. I think it's overdone, but I have heard that some analysts say the euro could move all the way up to 1.50. If so, I think the dollar will bounce from there. What strategies can I use? I have heard of shorting gold. Does that make sense?
The dollar has really suffered serious losses against the euro in recent years. From November 2006 to November 2007, the euro rose from less than 1.20 to its current levels near 1.47. Seven years ago, one euro could only buy 0.82 dollars! Times have changed. The long-term trend currently favors the euro and it is possible that the European currency continues its move to record highs.
It's also possible that 1.50 serves as a resistance level. Round numbers like 100, 10,000, or 1.50 often trigger aggressive buying and selling in the financial markets. Dow 10,000 was an example. Google (GOOG) at $500 was another. The EU/US at 1.50 might be another.
If you expect the EU/US currency pair to reverse direction around 1.50, there are several things you can do. You can open a forex account and trade the currency pair directly. These accounts provide a lot of leverage and are also available in mini versions for smaller investors. Many firms offer commissionless trading and make their money off the spread.
Forex trading does have some advantages. If you are interested in trading currencies, education is key. Stocks & Commodities has run a number of articles on currency trading. You might also talk to other traders about brokerage firms and other resources that specialize in foreign exchange trading.
Alternatively, you can short gold futures in a futures account or, in a stock brokerage account, short an exchange traded fund (ETF) that holds gold like the iShares Street Tracks Gold Fund (GLD). Since gold is dollar-denominated, it tends to move inversely to the dollar. However, the relationship isn't perfect. Gold has a tendency to move opposite to the dollar, but the correlation isn't 100%.
A relatively new tool for playing the EU/US currency pair within a stock brokerage account (that is cleared to trade options) is with the ISE US dollar/euro index ($EUI). The index is actually the opposite of the EU/US currency pair. It is based on the number of euros per US dollar, multiplied by 100. For example, with the dollar at 1.46 euros, the EUI index is trading near 68.50 [(1/1.46) x 100]. Since the index is dollar-based, it will move higher when the dollar is gaining ground against the euro. So if the EU/US pair does move to 1.50 and the strategist wants to be on a reversal, they can do so by creating bullish trades on the EUI index if it falls to 66.67.
GETTING THE MAX PROFIT FROM A BULL CALL SPREAD
I'm in a January bull call spread ($10 between strikes) that is now in-the-money. When can I expect the spread to widen to its full $10? It expires on Friday, so you would think by this time it would have widened sufficiently or I would have been assigned (the stock is $40 over the short call's strike).
This is a good problem to have. The bull call spread is generally created by purchasing an at-the-money option and selling an out-of-the-money option. At-the-money means the strike price is at or near the price of the stock. An out-of-the-money call has a strike price above the price of the stock. In-the-money calls have strike prices below the stock price.
If you have a bull call spread that is deep-in-the-money, then the stock or index moved higher, you are now showing a nice profit. In that case, you can close out the spread shortly before expiration and reap almost all of the maximum profit, which is computed as the difference between the two strike prices minus the debit paid for the bull call spread. However, if there is any time value remaining in the options, you will not get the full profit.
If you really want to squeeze the maximum profit out of the spread, wait until expiration and do nothing. Automatic exercise provisions will kick in. Your short call will be assigned to you and the long call will be exercised. The position will be closed out over the weekend for the full difference in the spread, minus commissions. In that case, you will have the maximum profit of the difference between the strike prices minus the debit paid for the spread.
If you are assigned before expiration, which is possible if the short call is in-the-money, then you would be short the stock after assignment. Then, when you exercise your long call, you would essentially just be covering that short stock position. Again, you would get the maximum profit from the bull call spread.
CLEARING UP THE CRACK SPREAD
I know some traders use the crack spread to play changes in gasoline and crude oil prices. What is it and how does it work?
Crack spreads trade on the New York Mercantile Exchange (NYMEX). The exchange actually offers two different types of crack spread futures and options. Both are used to play changes in the spread between crude oil and refined products (gasoline and heating oil). If a crack spread is negative, then the price of the refined product is lower than that of crude oil.
The first spread tracks the difference between crude oil and heating oil prices. The second looks at the difference between crude oil and gasoline prices. For example, if crude oil prices are rallying and gas isn't, I might believe that gas is going to go up, oil is going to go down, or a combination of both (closing the spread). At the NYMEX, you can trade this spread by buying or selling futures and options.
Originally published in the January 2008 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
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