Developing Forex Option Trade Direction

Housing data is one of the most important components in projecting currency moves and in anticipating a change in interest rate policies. A weak housing market portends a decrease in rates while a strong housing market raises fears of inflation and, therefore,market anticipation of interest rate increases or at least not cutting rates.

The trader needs to keep an eye on key sources of housing data and develop a focus on key indicators and data for each currency pair.U.S. dollar, the trader can track key housing equities to identify whether the prevailing trend is about to change. For example, KB Homes is a leading builder of single-family homes in the United States. Its stock price is a leading indicator of the housing market strengths or weaknesses.

We can see in Figure 3.9 that its downtrend was intact by the end of 2007. A forex trader who wants to anticipate whether the FOMC will stop lowering rates or will increase rates will be on high alert if the price breaks its downtrend line. We can see clearly that KB Homes, at the start of 2006, began a downtrend, coinciding with weakness in the overall housing market.

A call option just out of the money at $22 would be anticipating an FOMC decision to not lower rates, and therefore, this would be correlated with a recovering in the housing market. A call option playing a $22.50 strike price was priced at a premium of $1.60 compared to an at-the-money put of $2.98. This shows that the sentiment on the housing market recovery was significantly bearish.

The forex trader should watch this ratio periodically to see if it changes. If the ratio swings toward the call side, the trader should carefully consider calls on the U.S. dollar because a stronger housing market will reduce any probability of interest rate reductions (see Figure 3.10).The forex trader looking for a leading indicator of a housing recovery would want to see the price break the downtrend line.

He can also put on an options trade and play a recovery with a purchase of a $25 strike price. The option would need to be longer term to give time for the economy to start recovering. More important is the put/call ratio. It hit a high on December 27 of 31.7,with a moving average of the put/call ratio at 5.7. The average put/call ratio was 3.0.

This data showed that the mood of the market was still very bearish (see Figure 3.11).We can look at one more important piece of information regarding sentiment on this equity. We can compare the premium price of calls and puts. If the trader were to shape an option trade on the recovery of this stock and its breaking of a downtrend, he might consider an April 19 option and determine whether it is indicating the same bear sentiment.

We can see that the put/call ratio or premium price is 3.70, which is not a good sign for buying and therefore not a good support for buying U.S. dollars on anticipation that the FOMC would not decrease rates.Yet the price pattern and the option data on this equity do point to future conditions that may be leading indicators for a change in U.S. interest rate policy from decreasing rates to that of being neutral.

Also, it is beneficial to be looking at the volatility data.The volatility of this option is 65.29 percent. If it starts declining, it could be a sign of a bottoming out. If it coincided with the price probing the trend line and breaking out, the Housing Data outside the United States Anticipating the direction of interest rates in other countries is a key method for shaping a bullish or bearish sentiment regarding trading currency pairs other than the dollar.

The housing sector is a reliable indicator in almost every country that has a floating currency.Let’s look at some pairs.The British Pound This currency movement went to historic highs against the U.S. dollar and then retraced back. The cause was a fall in housing prices after a decade-long boom (see Figure 3.13).The direction of the GBPUSD followed a significant slowdown in housing prices and in mortgage approvals in Britain. Seeing this data as a put on the GBPUSD would be following the sentiments of the market. (Source: British Bankers’ Association, Royal Institution of Chartered Surveyors, Nationwide Building Society.)