Sell Short the Currency Shares Australian Dollar Trust October, 2012 (FXA) $105-$108 call spread at $0.35 or best
9-4-2012 – 2:00 PM EST
expiration date: October 19, 2012
Portfolio weighting: 10% = 45 contracts on a net delta adjusted basis
This is a bet that the Currency Shares Australian Dollar Trust October, 2012 (FXA) trades at or below $105.35 on the October 21 expiration in six weeks. That means that the cash market has to move up 3.1 cents, or 3.0% from today’s level of $102.25 for you to lose money.
I saw this one coming a mile off, and have been urging listeners of my biweekly strategy webinars to use any good entry point to sell short the Australian dollar. But I missed my own chance to sell at the recent top at $105. I should try reading my own research someday.
Here is the base case to quit singing “Waltzing Matilda” in the shower every morning. Australia’s largest export is iron ore, which accounts for 25% of the total. The problem is that the three-year slowdown in the Chinese economy has dragged the price for iron ore down 25% in the past month, and 50% from its 2011 top. It is the world’s second largest bilateral trade and a valuable window for traders and investors on the health of the global economy.
The country’s largest producers, Broken Hill (BHP) and Rio Tinto (RIO) have taken a major hit to profitability, and have begun delaying or cancelling new mines. To learn more about this foreboding developing in depth, please click here for “BHP Cut Bodes Ill for the Global Economy” at http://www.madhedgefundtrader.com/bhp-cut-bodes-ill-for-the-global-economy/). The hemorrhage is now predictably starting to feed into weaker Australian GDP growth figures.
Last night’s weaker-than-expected Chinese Purchasing Manager Index figure was the stick that finally broke the camel’s back. The Aussie responded by plunging a full penny, and slicing through the bottom of its recent trading range at $1.03.
The ideal way to do this trade was to buy something like an (FXA) November $101-$105 put spread. Since we are well off the top, there is no point in pursuing the Aussie with such an aggressive position at this level.
However, there is still plenty of nice, juicy premium left in out-of-the-money calls sitting on the table. I am more than happy to reap these in the form a short position in the (FXA) October $105-$108 call spread.
Tonight the Ministry of Finance in Canberra announces the most-recent GDP figures. If they come in weak, as I expect, the Aussie may accelerate its downward descent. If they come in better than expected, use the opportunity to add a short position in the Aussie at better prices. Neither the iron ore trade, nor the Chinese economy, are things that turn on a dime, as the capital investment lead times are so long.
If this spread expires anywhere under $105, as I hope, your total profit should amount to (45 X 100 X $0.35) = $1,575. That gives you a profit on this six-week play of 1.57% for the notional $100,000 model portfolio.
Keep in mind that this is a solid “RISK OFF” trade, as it bets on the continued slowing of the global economy, especially for hard commodities like the base metals. It can therefore be used to offset the existing aggressive “RISK ON” trades we already have in Apple (AAPL) and gold (GLD).
Don’t place a market order for this trade or the floor traders will rip your eyes out. Don’t place individual orders for the legs either. Instead, place a limit day order in the middle market to sell the entire call spread only around $0.35, and wait for the market to come to you. It will find you.
The market can be illiquid for the deep out-of-the money $108 calls. You need this leg to cap and define your risk, as well as minimize your margin requirement for the position.
If nothing happens then start raising your bid for the spread in 5 cent increments until something happens. You might also consider scaling into less leveraged short positions, such as through selling short the ETF (FXA) on any rally.
If you can’t get done at a price that you are happy with, then walk away and wait for the next trade alert. There will be plenty of trading opportunities in coming months. The same is true if I have failed to adequately explain this trade and you don’t understand it.
These are the trades you should execute:
Sell short 45 October, 2012 (FXA) $105 calls at……$0.40
Buy 45 October, 2012 (FXA) $108 calls at………….$0.05
Net Premium Proceeds:………….…..………………$0.35
Time to short Crocodile Dundee