Jared Woodard: FXA (incl video) Moving Lower in the Land Down Under
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There are several reasons to look for a decline in the Australian dollar versus the U.S. dollar in the coming months, and the relative cheapness of options on the AUD means investors can take advantage of this scenario in a cost-effective way.
In the attached video, I explain two reasons why I'm looking for a decline in AUD/USD. The first is that the ongoing Chinese transition from export-oriented to consumption-based growth is a problem for the export-reliant Australian economy. As Asian economies rely less and less on industrial commodities, Australian miners and exporters will be under increasing pressure. Second, the interest rate picture has diverged significantly from currency values, and given the likelihood that rates will stay flat or be cut further, a closing of the rates/currency gap would suggest more downside for dollars.
Another indicator of downside risk for the dollar is the worsening sentiment among business directors. In a survey published this week, the leaders of major Australian companies expressed serious pessimism about business conditions.
"Overall, the director sentiment index now sits at just 56.3 points, compared to 93.6 points at the start of 2011. A score of 100 is "neutral", while 200 would be "optimistic".
The directors' outlook for the Australian economy is dire, with 56 expecting growth over the next year to be weak or very weak. They expect the value of the Australian dollar, the official cash rate and wages growth to decline while unemployment rises."
The recent strength we've seen in the Australian dollar does no favors for exporters, so we can expect the central bank there to lower rates in future, and the weak rates picture and worsening fundamentals should give more downside to the currency.
Option implied volatility is at multi-year lows at the moment, so we are buyers of put options on the expectation of increasing volatility.
Trades: Buy to open 1 FXA March 102 put for $1.90 and sell to open 1 FXA March 98 put at $0.75.
We are buying some time to allow this thesis to play out, and as mentioned in the video, the favorable implied volatility skew means we can reduce our cost basis using a vertical spread without giving up too much downside potential. Our risk is limited to the premium paid for the spread, and we will expect to hold this position for some time.
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