Forex Options and Futures Point to British Pound, US Dollar Recovery.

Forex Options Futures market shows the trend of the US dollar to almost all major partners near historic lows, A one-sided attitude suggests the US dollar is approaching a major turning point. The key question remains on the timing of this turnaround as US dollar sentiment has long been extreme. The main exception is the position of the US dollar against the British pound, as the recent price correction suggests that the GBPUSD has set a major medium-term low.

Volatility expectations have risen sharply due to the recent decline in the US dollar. We usually see big swings in the market when volatility is at or near its peak. Of course, predicting the peak of potential volatility in the FX options market is an achievement in itself. As it happens, we understand that the US dollar could continue to lose value through short-term trading. However, the subsequent decline in the US dollar only increases the potential for a market correction and increases the chances of a dollar recovery.

Futures positions indicate that non-dealers (usually large speculators) have become very pure euros against the US dollar. Indeed, speculative positions have been the longest since trading around $1,6000 in early 2008. We always warn that over-positioning sentiment may remain extreme for a long time. However, it is interesting to note that the availability of options actually indicates that many traders are starting to hedge against EURUSD weakness. It is possible that EURUSD has reached its highest level.

Futures Sentiment British pound versus US dollar options are quite different as traders actually have long versus the US dollar versus their UK counterparts. Indeed, purely non-trading positions recently hit an all-time low, underscoring the extreme decline in the GBP. The CFTC COT data is always at least 4 days late, but the increased risk of a forex option reversal indicates that we are in an upside state. With such a broad bearish trend, we can predict the GBPUSD's future range as traders hedge their short positions.

The influential rise in the Japanese yen (USDJPY) has led to an equally influential position in the futures market, becoming the shortest USD/JPY since non-dealer trading below 90. However, recent events suggest that their traders are pulling away from the JPY. Granted, the longer term bias but rebound in FX risk suggests sentiment is close to the JPY's biggest drop in the last 90 trading days. Reading the mood alone is, of course, completely incomprehensible; You may have to wait for more clarity before making a specific yen forecast.

Traders saw the Canadian dollar rise (USDCAD for short) during the most recent trading session, with FX futures data showing the biggest gains since the pair traded evenly. However, with the FX market growing near neutral against USDCAD, the sudden shift in FX options marks the start of a near-term turnaround. It is always very difficult to make top-down options, but we would say that USDCAD risk remains high in the coming months of trading.

The position of non-tradable futures on the US dollar/Swiss franc pair remains at its lowest level in 5 years, indicating a significant change in sentiment. Long positions in Swiss francs (short USDCHF) outperform short positions by more than 20,000 Not surprisingly, USD/CHF will sell lower. However, the last time pure long positions in CHF rose to this level was in 2004. In December. At that time, USDCHF hit a very low level and gained more than 1,000 points in 10 months. Past performance is no guarantee of future results, but USD/CHF likely has the least.

We continue to call for a steady decline in the Aussie dollar as sentiment has been going to extremes for some time. Non-trading futures traders remain the longest net on AUDUSD as the pair sells above 0.90 but this period of change remains very tough. Sentiment in the forex options market has historically been extreme and moderate since then. Our earlier AUDUSD callback demand was clearly premature and highlighted the difficulty of anticipating a change in sentiment. However, we believe that extreme moods increase the risk of relapse.

The New Zealand dollar/USD pair is very similar to the AUDUSD and opens the door for a short-term decline in the event of a significant trend reversal in sentiment. Last week, purely non-trading positions on NZDUSD futures remained the longest since the pair hit a significant high in July 2007.

Written by David Rodriguez, a quantitative strategist