Historically I’ve focused on trading the spot currency market, but I’ve begun playing around with options on currency exchange trade funds. The ETFs I’m practicing with are offered by Rydex Investments under the brand CurrencyShares. These ETFs hold the underlying spot currency, and derive their value from the spot price. For example, today the CurrencyShares Euro ETF (FXE) closed at $136 per share, while the spot price closed around $1.3618 on my daily candle. Notice the decimal shift to derive the share price. I thought I’d walk through an example trade for today’s post.

As usual, my trade plan begins with a support or resistance trading opportunity. In this example I’m using the CurrencyShares Canadian Dollar ETF (FXC) shown in the chart above. You can click the chart for a larger image. The ETF holds a spot position in the named currency, therefore you can translate spot strategies to an exchange based strategy through these ETFs. You could also use support and resistance on the FXC chart alone, but I like to correlate the ETFs to the spot market. Since FXC holds a trust of Canadian dollars, a trader who is bullish USD/CAD would take a bearish bias against FXC because they are betting against the Canadian dollar. Using the charts, a trader might decide USD/CAD is trading within support. If they decide to commit themselves to a bullish USD position, the trade could be expressed by going long USD/CAD, short FXC, or executing an option strategy on FXC. Let’s look at the pros and cons of each trade strategy.

Going Long USD/CAD

If the trader buys USD/CAD they are committed to the market until either they take profit, or they are stopped out. In this example, the appropriate stop loss is below $1.02. If the trader bought USD/CAD right now, a stop loss of at least 100 pips would be appropriate. Assuming they trade one $10,000 mini lot, the total risk would equal $100 using 100:1 leverage. Additionally, the stop loss would offer no protection from volatility. If the USD/CAD moves lower before it moves higher the trader may be stopped out on what ultimately was the correct position. If the trader is stopped out, and enters the trade again the risk has been doubled.

Shorting FXC

Alternatively the trader could short FXC, however it may be tough to find shares to borrow in order to short. The trader would ideally place a stop loss above supply which exposes the same volatility risk as the spot trade suffers from.

Buying a Put Option

When you buy a put option, you are betting the value of the underlying issue will decline. The strike price declared in the option is effectively the price at which you will be able to short when you exercise the option. The trader will pay a premium when the option is written (opened) which effectively is their maximum loss on the position. For example, I can purchase an FXC put option with a strike price of $96 for a premium of $95.00. This premium is equivalent to a 95 pip stop loss in the spot market on one mini contract, but represents the maximum loss the option will suffer. Even if the market moves 100 points against me, my option is still valid until expiration unlike a stop loss. Ideally, the price of FXC will fall giving my option greater value than a break even price of $95.05 when I exercise it. The best part is this option will expire on April 10th giving the market 39 days to work itself out before the option must be exercised. Unlike a stop loss, the risk is paid up front and you have 39 days to make a profit regardless of what price does between now and then.

There are other advantages to the option we can discuss in a future post. I’ll keep you updated on this example trade as we get closer to expiration.

Best of luck,

Ryan