This is a weekly column focusing on ETF options by Scott Nations, a proprietary trader and financial engineer with about 20 years of experience in options. More than 100 million options on ETFs were traded in February, and because ETFs and options are among the fastest-growing financial vehicles in the world, it only makes sense to combine the two. This column highlights unusually large or interesting ETF options trades to help readers understand where traders believe a particular ETF may be headed. In doing so, Nations examines the underlying options strategy.
Fixed-income ETF investors have some difficult choices to make these days.
One the one hand, they can invest in the U.S. bond market, where the 10-year government note yields about 2.2 percent. That yield seems to be headed higher given speculation that the Federal Reserve is ready to start raising the fed funds rate.
Alternatively, they can invest in a euro-denominated bond market like Germany’s, where the 10-year government note yields a tiny fraction of the U.S. rate, about 0.3 percent. That rate, unlike rates in the U.S., seems to be headed lower thanks to the European Central Bank’s quantitative easing purchases of eurozone bonds.
It’s not just Americans choosing to invest in U.S. bonds, investors all over the world are choosing to invest in the U.S. But Americans have an advantage: If you want to invest here, you need dollars, and we already have them. If you live somewhere else, you need to begin by selling whatever currency you own and buying dollars.
The result for the dollar over the past year has been exactly as you’d expect: It has rallied impressively. This article explores the possibility, through the lens of the ETF options market, of that rally having gone a bit too far. So let’s look at a currency ETF that has rallied smartly along with the dollar.
One ETF that allows traders to speculate on the performance of the dollar is the PowerShares DB US Dollar Bullish ETF (UUP | B-73). It has rallied by more than 23 percent during the past 52 weeks, as the chart below shows.
UUP is based on a basket of six foreign currencies, with the majority of the index made up of the euro. UUP, to be clear, is designed to appreciate as the dollar appreciates against these currencies.