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How does the AUD survive?

December 29, 2010

What the heck is happening with the AUD?  How does it survive at these levels for another 6 months?

  • The economy in Australia is starting to slow dramatically.
  • The Australian housing market is slowing dramatically – and there is a whiff of panic in the air.
  • Inflation is not quite high – 2.8%.  Various measures of core inflation look tame as well.  2.8%!
  • China is raising rates to stem their inflation – which should decrease inflationary pressure on Australia.

All of this points to a rate cut at some point rather soon, right?  The Carry Trade is a big reason why the AUD is in constant rally mode.  Rate cuts kill carry trades, we saw a AUDUSD unwind earlier this year after the flash crash.

But here we are at AUDUSD parity.  At some point the AUDUSD is going to lose 20 handles in a few days, like it did in 2010.

The goal is to make this trade pay off.  Short term options lose so much value so rapidly, but long term options may not move in price nearly as much.  Medium Term options are very difficult to use because they change from a long term option to a theta drain at some point.

A series of short term, deeply out of the money options?   You could probably pay a total of 1% for 6 months worth of these, and then expect to make 5-6% if the scenario pays off.   Not bad risk reward.  These are the Feb Puts, so you have roughly 40 days until expiry.   You could get the 91s for roughly .10.

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