The DeCarley Perspective Trading Newsletter

Record net speculative shorts in Euro, risk to the upside?

This newsletter was distributed to DeCarley Trading brokerage clients on January 8, 2012 

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Thank you for choosing DeCarley Trading.  We are proud to offer the DeCarley Perspective as an informational guide to our clients and subscribers.  We hope that you walk away from the newsletter with a better understanding of market fundamentals, as well as technical and seasonal factors. 

 

**There is substantial risk of loss in trading futures and options.

**Past performance is not indicative of future results

On the radar:

  • Record net speculative shorts in Euro, risk to the upside?

 Euro Currency Futures

The Euro currency has been treated like the "red headed step child" of the financial markets for quite some time now, but it appears as though Euro bears have become too complacent.  Perhaps their comfort is magnified by the fact that nearly all of the "talking heads" on business news stations are consistently pessimistic in regard to the currency.  However, as we all know, popular trades have a tendency to become overcrowded and become vulnerable to sharp corrections, or even trend reversals, as traders unwind positions.  Although most analysts seem to insist the risk of the Euro is to the downside, we are taking the opposite stance.  The current environment "feels" a lot like it did in the summer of 2010; just as "everyone" was screaming about risk of a collapse to par with the dollar the Euro violently reversed course, leaving the bears with painful wounds.

According to the latest data compiled by the CFTC, large speculators (so-called smart money) are net short 137,746 Euro contracts (this figure includes bearish option positions measured by delta).  However, the data was measured on the previous Tuesday and in light of the Euro's three day collapse, our guess is that the actual net short position is near 150,000!  Keep in mind, 137,746 is the largest net short position ever recorded in the large speculator category.  In previous instance in which the net short position exceeded 100,000, a significant rally ensued. 

As if a record net short position by the "smart-money" wasn't enough to wave a red flag of concern in regard to the bear market in the Euro, small speculators (known as dumb money) are also short the equivalent of 29,838 contracts; this leave the combined speculative position at a record 167,584.

The "fly in the ointment" so to speak, is the fact that Euro seasonal pressured tend to maintain a bearish bias from early January through the end of the month. Nonetheless, seasonal tendencies in the currency markets haven't been an accurate predictor of price in recent months, so in this instance we are opting to focus on the overwhelmingly bearish trader sentiment rather than seasonal tendencies.

Clearly, it is nearly impossible to pick an exact bottom but the chart does give us a few ideas of where it might be.  In the near-term, the Euro faces down-trend support just under 1.2700 and should that level fail, we think 1.2550 should be an opportunity for the bulls.

If you agree that the Euro could be near a short-term bottom, there are a few ways to play the upside.  We like the idea of selling puts in both the February and March options (preferred strategy).  Many clients are holding short 123 puts in March left over from a strangle initiated a little over a week ago.  If you do not have this trade on, you might consider selling these (currently valued near 48 ticks or $600), or selling the 122 puts for about 34 ticks ($425).  We also like the idea of selling the March puts at strikes of 118 or lower.  The 118's are currently worth 50 ticks or $625 and the 117's (as recommended on Friday) are worth 41 ($512).

Those that don't like the idea of open ended risk, might look to simply buy lottery ticket call options such as the March 138's for 20 ($250).  Others with limited capital might look to begin establishing a scale trade using the e-micro futures contracts. For instance, a trader could purchase a contract (or a few depending on risk tolerance and capital) at the current price with the intention of adding contracts at the support areas noted above. 

 Euro Currency futures contract

DeCarley Trading
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**There is substantial risk of loss in trading futures and options.

Past performance is not indicative of future results.  The information and data in this report were obtained from sources considered reliable.  Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any securities or commodities.  Any decision to purchase or sell as a result of the opinions expressed in this report will be the full responsibility of the person authorizing such transaction.

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