Currency markets took center stage to start the week as month-long intervention rhetoric from the Japanese Finance Minister (Azumi) was finally put into action on Monday (after the USD/JPY reached fresh all-time lows below 75.50).  The unilateral move to sell the Yen brought the pair to a test of 79.80 before leveling out in the low 79 region, completing a move of more than 400 pips in less than an hour.  The range values in the USD/JPY have slowed to a near halt since the summer but the recent injection of volatility was the result of a rumored 1 trillion Yen’s worth of trade flows carried out by the Bank of Japan.

Additional comments suggested that this type of intervention strategy could continue, given that currency values in Japan (according to Azumi) are not reflective of economic fundamentals and that recent moves in foreign exchange have been generally one-sided.  Apparently, the Japanese Finance Ministry did ask the central banks of other nations for assistance in reversing Yen strength but at the moment there is no evidence to suggest that these requests were honored.  The solo nature of the intervention does put the validity of the latest moves into question, so a significant pullback from today’s highs would not be at all surprising.

Since the trade flows were specifically focused on the USD/JPY, the total result of the intervention was Dollar strength, with Gold and the high yielding currencies also seeing significant declines early in the Asian session.  The Euro has pushed through psychological support at 1.40 and the downward move is being aided by the fact that Fitch released a statement over the weekend suggesting that the 50% write-down in Greek debt (which was part of the three-fold agreement at last Wednesday’s meeting) would fall into the “default” category.

While the headlines focused almost entirely on the volatility seen in currency markets macro releases were essentially ignored.  Official data did show that Japanese manufacturing PMI managed to regain the expansionary 50 level (after the 49.3 reading seen in August).  Second-tier confidence surveys out of the UK, however, were disappointing and did nothing to help the declines seen in the GBP in Monday’s trading.

In US data, personal income showed declines while personal spending was seen unchanged, which is less than encouraging for consumer debt forecasts.  The University of Michigan consumer confidence survey rose to 60.9 (from 57.5 the previous month).  The lackluster data left US equities relatively unchanged on Friday as the dust settles from the massive bull moves seen on Thursday.

Technicals:

The EUR/USD gapped lower to start the week, with prices testing areas below 1.40 before seeing modest bounces higher.  The impulsive move is not encouraging for the pair and if we see a break of resistance turned support at 1.3960, we will expect a fall to at least the 38% retracement seen on the 4H charts, which is also where the 100 and 200 period EMAs are clustered.

The DAX is meeting resistance at its 200 day EMA, which is just short of its daily 61.8% Fib retracement at 6550.  Expect prices to drift lower until at least the 100 day EMA at 6120 before considering short term buy entries.  Resistance now seen at 6445.

Last week we started looking at options as another trading vehicle available to spread traders. In our introductory article we covered all the basics of trading options with spread betting and promised to analyse some possible strategies to implement in times volatility is huge. Today we will start with two basic strategies that can help you when volatility is high and you don’t know which way to go: the long straddle and the long strangle. And of course you could also profit from sideways markets by doing the opposite and selling a straddle or a strangle.

There are times under which markets are volatile as there are certain events, which you expect to come embraced in volatility. A corporate earnings announcement, a decision on interest rates, a GDP report announcement, are just some examples of situations in which volatility is expected to pick up making asset prices move very quickly. In such situations you are assured to see your portfolio value change rapidly but you still need to guess market direction before opening any position. That is the most difficult part of spread betting and at the same time the most important one.

But fortunately, even when you are not sure about the direction a market will move, you can still use your spread betting account to do some effective trading. By carefully selecting a pair of options you can set up a trap to get some juice from the market without needing to care about direction. One call and one put option is what you need to play with volatility. Today we will analyse two useful directionless strategies that just use one call and one put option.

Setting a Long Straddle

The first and simpler strategy is the straddle, also known as long straddle as it involves long positions.

The straddle is a neutral strategy in the sense direction does not matter. The only concern is with volatility and thus price movement. The strategy involves buying both a call and a put with the same strike price and expiry date. The strike should be near the underlying asset price, or saying other way, the options should be at-the-money or near it. To make a profit out of this strategy, one needs the market to move away from the options strike. The more it moves away from that price, the higher the profits will be. Unfortunately this is a costly strategy, meaning that you need a large movement in the underlying asset price in order to cover your initial cost.

In terms of risk, the maximum loss is equal to the options cost and the upside potential is virtually unlimited. There are two breakeven points, depending whether the underlying asset goes up or down. The upside breakeven is equal to the options strike plus the options cost. The downside breakeven is equal to the strike less the options cost.

A Straddle Example

Let’s assume you want to implement the straddle strategy on FTSE 100. In order to better simulate reality, we got real price data from IG Index a few days ago. The FTSE was trading at 5,560 at that time.

In order to build the strategy, you should choose some options that are at-the-money. In this case you can choose a daily call and a daily put, both with strike price of 5,560. Those options expire at the end of FTSE session – 16.30. You can try with different expiry dates.

For the sake of our example, the call was worth 21.05 and the put 19.55. The total cost to set up the strategy would be £40.60. Applying what you’ve learned before, in order to breakeven, you need FTSE to move above 5,600.6 or below 5419.4. That is a move of 0.75%, a really huge one. But in times the market is volatile as it currently is, it may worth implement such strategy. There are certain advantages deriving from a setup like this. First of all, you don’t need to guess direction as you have with normal spread trades. Secondly, you do have a maximum loss set up from the beginning. That is different from a stop loss in the sense that as long as the market goes up or down it does not matter the path it takes while a stop order will kick in when the market departs too much from the direction of your trade.

At maturity date, you basically need the market to rise or decrease more than 0.75% to make money. If that is not the case, you will lose a maximum of £40.60, the cost of the options.

Setting a Long Strangle

Let’s now look into a similar strategy – a long strangle. Like for the straddle case, this strategy is directionless, and you just have to care with volatility.

The strangle involves buying both a call and a put option with the same expiry date but with different strike prices. Usually, the options are out-of-the-money, reducing your initial outlay. The lower initial cost, means lower maximum loss but, at the same time, a reduced profit. You will need a higher price movement to breakeven, when comparing to the straddle.

In terms of risk, the maximum loss is equal to the cost of the options like in the straddle case, and the upside potential is also unlimited, although always less than in the straddle case. There are two breakeven points. The upper one is equal to the call strike plus the options cost and the lower is equal to the put strike less the options cost.

A Strangle Example

Let’s use the example above with FTSE 100 quoted at 5,560. We need two out-the-money options, one call and one put. Like in the above example, let’s pick daily options: a call with strike 5,600 and a put with strike 5,520.

Real data taken from IG Index values the call at 6.35 and the put at 6.95, for a total initial outlay of £13.30. In order to recover that expense, you need FTSE to go above the call strike plus that cost, or below the put strike less the cost. Basically FTSE should go above 5613.3 or below 5,506.7 – a movement of 0.96%.

The strangle costs you less but will require a much larger move in the underlying to make you money. That’s the cost of the extra protection. The more out-of-the-money the options were, the less they would cost, the higher the protection, and the larger the underlying would have to move for you to profit.

Putting It All Together

Let’s now look a the differences between the straddle and the strangle with the help of a simple graphic plotting the underlying price and profit.



It is clear from looking at the above chart that there is an exchange between potential profit and maximum loss. The strangle will protect you better in case volatility does not pick up, but at the expense of decreased profits for any given underlying price, when volatility does it job. The intersection of the lines with the x-axis also shows that you need a larger change for the strangle to breakeven.

The following table summarises all relevant data deriving from both strategies. The first part shows the initial parameters. The risk metrics follows, showing the key points that you should care with, and then there are some example values.

Strategies Data

Strategy Setup

Risk Metrics

Example Values

The straddle and the strangle are great strategies for spread betting traders when they don’t know the direction a market will take and are expecting a large volatility, but are too costly. In certain times, in which some volatility is expected but not huge movements, some other cheaper strategies may be preferred. Two of those are the short butterfly and the short condor that we will review in our next article.

Risk assets remained supported through the New York session as the optimism created by the EU Summit meeting keeps markets elevated and news headlines continue to discuss the possibility of additional purchases of European debt by the Chinese government.  US macro data was also higher than expectations so traders who are long equities had little reason to close out their positions.

The EUR/USD holds steady, another leg higher at 1.4150-1.4250 while the USD/JPY is heavy at 75.80-76.10.  Stock markets had a strong performance yesterday, with the S&P 500 showing a close 3.4% higher, while the CAC and DAX performing even better with gains of 6% and 5%, respectively. US macro data was seen with the third quarter GDP release, which came in at 2.5% for the yearly figures and jobless claims matching market expectations.

The French President (Sarkozy) made comments, re-iterating the importance of the steps taken at Wednesday’s meeting and suggested that any severe devaluation of the Euro would be detrimental for the continent.  In addition to this, he said that France’s official GDP forecast is now seen lower, at 1% (from 1.75% previously) and that a new set of austerity measures will be implemented and reduce government spending by 6-8 billion Euros.  In other Euro-area news. S&P lowered the credit rating of Cyprus (to BBB) with a negative long term outlook.

In currency markets, the sum effect of this week’s meetings has led to heavy selling in the US Dollar, which is relatively surprising given the price activity that is being seen in the Yen.  Market reaction to the EU results has been largely risk positive, with the only major exception being seen in the USD/JPY, which continues to grind lower.

Since this is generally not what market analysts would expect, the Bank of Japan is likely to become increasingly concerned (as this year’s trend in Yen strength refuses to show any meaningful reversal).  Given this, risk of intervention is rising and the potential volatility in the USD/JPY could change without warning.  Last night, there were no official comments in line with this possibility but short positions in this pair should be viewed in light of this potential outcome.

In Sweden, the Riksbank kept rates steady at 2% during its policy meeting (with two dissenting votes), and downgraded both its GDP and CPI forecasts.  The 2011 figures are now seen at 4.2% in GDP and 1.9% for consumer inflation.

Technicals:

The AUD/JPY has bounced strongly off of weekly support at 72.  This area is now a clear double bottom and suggests we will see a retest of resistance at 90.  Hourly charts are showing lower highs, however, so we will see to see a break of Fib resistance and the downtrend line in order to open up the highs at 90.

The DAX continues its recent rally and is now testing resistance at the 200 day EMA.  This area is relatively close to the 61.8% daily Fib level, so risk to reward favors short positions relatively soon.  First support comes in at 6365.

Risk assets were higher overnight as details from Wednesday’s EU Summit meeting helped push markets higher.  The main headline was the IIF agreement to accept a 50% write-down in the outstanding Greek debt held by private investors.  The write-down (15% in cash, 35% in bond exchanges) was put in place with the aim of reducing Greek debt to 120% of annual GDP by the year 2020.

The agreement included an EFSF enhancement which would leverage its funding capabilities to 1 trillion Euros.  The specific details for how this leveraging would be carried out were not released and apparently have not been decided.  The last part of the story involved bank recapitalization, with reserve requirements being raised to 9% by the end of 2012.

On balance, markets have reacted favorably and this is likely to continue in the short term.  Further along in the time horizon, however, is another story as significant questions have not been answered (i.e. the exact methods that will be used to leverage the EFSF, or the ways the EU/ECB/IMF will divide their own assumed losses). But for the moment sentiment is being supported, risk assets are making gains and have the potential to run further.

In Japan, the BoJ left held its monetary policy meeting (leaving its base rates unchanged) with the main action being seen in the decision to make policy more accommodative (in purchasing an additional 5 trillion Yen worth of JGBs). Many have argued that this stimulus is insufficient, though, as it only amounts to 1/10 of the program that is already in place.  With this in mind, there is little to suggest that this move will have a material effect on the extreme levels that are being seen in the USD/JPY this week.  Central bank intervention is a much more likely scenario and because of this, short positions in USD/JPY (especially at these levels) should be viewed as a risky proposition.

In New Zealand, the RBNZ also held its policy meeting and left rates unchanged (at 2.5%).  The accompanying statement, however, was a bit of a surprise as the bank appears to be holding onto its hawkish bias.  Given the current level of global uncertainty and downward revisions to global GDP forecasts, it is relatively surprising to see a central bank more concerned with inflationary pressures than it is with domestic growth prospects.  Macro data will be key going forward to see if growth prospects remain in line with the RBNZ expectations.

Technicals:

Technical indicators in the EUR/USD are starting to show significant shifts longer term.   We have seen a break of the daily 61.8% retracement and a close above this area will confirm the latest move.  Previous bullish indications included the break of the 100 and 200 day EMA and the MACD push into positive territory.  The rally has been strong, so a period of consolidation is expected but longer term, these are clearly positive signals.

The S&P 500 has broken its longer term Fib resistance at 1255 with very little pullback seen so far.  Momentum indicators are bullish, so we need to see a break back below support at 1220 to turn the bias back to neutral.  Buying dips is the preferred strategy, short term.

IG Index, the leading UK spread betting company, has just launched another mobile platform, this time for the Apple iPad.

According to the company, it has experienced 300% rise in mobile trading over the last year. With the launch of mobile applications clients started trading when they are on the move in addition to when they are in front of their desktops. IG developed software for several platforms including iPhone, Android, BlackBerry, and Windows Phone 7. With the rise of tablets, a software specifically designed for the Apple iPad was missing, but can now be downloaded by all IG clients.

Commenting on the launch, Tim Hughes, Managing Director of IG Index, said: “The latest generation of smartphones has given us the opportunity to drastically improve our mobile spread betting software. This has been accompanied by a significant uplift in clients using their mobile handsets to deal on the move. We are confident that the bigger screen of the iPad and the accompanying improvements in functionality we have been able to deliver will make this application just as popular.”

Due to the dimension of its screen, the iPad allows for much better functionality than any other mobile device. Instead of needing to constantly click on buttons to change between charts, open positions, watch lists, and other information, clients can see most of what they want in the main screen of the iPad application as in the web platform. This will allow for an enhanced trading experience that will let traders forget about their desktops.

Spread betting providers are now spending a significant part of their resources in the development of their software. Competition between companies already brought spreads down and they are now competing for innovation.