Riding the EUR/USD to parity

April 1, 2015 03:00 PM

One can almost hear the sound of the EUR/USD sliding. The May 8, 2014 peak of 1.3993 looks like an ancient landmark, from before the great flood of quantitative easing (see “Lookout below, right”). Only one year later, EUR/USD parity is within sight. The last time the EUR/USD was at parity with the dollar was in October 2002. With European Central Bank President Mario Draghi spending nearly $67 billion per month on European quantitative easing, bond yields have fallen and the EUR/USD has no fundamental reason to strengthen. How can the forex trader join the ride down to parity?  

With par as a big fat round number, it is not too late to take a short position in the spot forex market. The question is timing. There may be an interim correction before the next leg down. Perfection here is the enemy of the good.  

Don’t put all risk capital in a short naked short position. One-third of risk capital could be used to enter the market on a short, the second third can be triggered by a swing failure, where the EUR/USD retraces (perhaps 100 pips) before resuming the ride down, and a final third could purchase an out-of-the-money put with defiled risk. This avoids an all-or- nothing approach. There is a lot of time to be right on the  900 pip distance to parity.   

An approach to short the EUR/USD with a defined risk is to use weekly binary options. This can be done at the North American Derivatives Exchange (Nadex) or internationally at IG Markets. Weekly binaries have fixed payouts. Each contract settles at zero or 100. The risk is the amount put on a long or short position. A short euro is established through a position that requires that the underlying market not rise above a certain strike price. If the trade is successful, the trader collects the difference between what he paid for margin and either zero or 100. 

You can sell an out-of-the-money weekly binary around 60; this would return 150% on the risk. For example, on Monday, March 9 at 6:30 a.m. the EUR/USD weekly binary with a strike  of 1.0825 was bid at 64. If the EUR/USD declined beyond 1.0825, the trader would keep the bid and the triple digit return (see “Binary ladder”).   

An advantage of this approach is that there is a known and maximum risk, allowing a trader to not miss a downside move by simply putting on a trade on a Monday morning and letting it work. Of course, one can always get out of the way if a bullish move occurs.

An equity strategy for playing a weakening EUR/USD can be made by buying shares in an exchange-traded fund (ETF) that  shorts the EUR/USD. The ProShares Short EURO (EURFX) is one example of such an ETF.  

A different and more classic approach is to bypass the U.S. dollar entirely and play the weakness in the euro by trading the EUR/GBP cross-pair. There are many fundamental reasons to consider this approach. The European Central Bank is weakening its currency. In contrast, the Bank of England is on the verge of raising interest rates. The euro has and will continue to fall against the British pound. So in trading the EUR/GBP, the forex trader is using both the pressure to weaken the euro as well as the pressure to strengthen the pound, and taking out any risk of dollar specific weakness outside of euro fundamentals that could spoil the trade. 

The technicals are compelling as well. The EUR/GBP monthly pair has broken through a downward channel that has lasted five years. When such a pattern breaks, it is strong signal that the price action has experienced new energy to continue in the direction of the break.   
For these reasons, forex traders have before them a compelling opportunity on selling the EUR/USD or the EUR/GBP.

About the Author

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.