Is EUR/USD Showing Signs of Strength?

Despite Grexit Woes the Euro has shown a lot of strength over the past week against the US Dollar.  However, it seems that the market has already taken into account that Greece will receive a bailout package. Greek banks received the emergency funding they needed, the Greek parliament voted the necessary structural changes needed to continue negotiating and the conditions Greece will be subject to will be stricter than the ones first proposed, which can be seen as strengthening the single currency with moves taking EUR/USD back above 1.11. During the crisis and bailout of Greece, the pair tested 1.08 lows as tremors in the markets emerged.

Higher Interest Rates Ahead in the US

The FOMC will be having its regular monthly meeting this Wednesday and most forecasts are for keeping interest rates on hold. Higher interest rates in the US may push the USD up and devalue the Euro which has interest rates close to zero, where they look like remaining at least another year. In the US the higher GDP growth rate and larger job creation numbers have given the Fed cue to raise interest rates to defend against inflation. In Yellen’s recent speech to congress she made it clear that rates would go up at some point before the end of 2015. Given that inflation numbers have been very stable and failed to show any signs of rising, it would seem very likely that Wednesday’s meeting will serve more to analyze data and prepare the markets with more talk as to when exactly to expect a hike in rates. Yellen’s speech after the meeting should give more indications of future action from the Fed; talk on a hike as early as September may send EUR/USD down sharply whereas talk of further delays to the end of the year should give Euro a boost. Of course her wording may not be as clear as one hopes.

A delayed rise in interest rates in the US and a solid solution to the Greek crisis could give the Euro some more room to strengthen further in the coming weeks and continue its retracement upwards from its low of 1.0460 on March 12th this year.

A Look at Technicals

Looking at the EUR/USD daily chart we can see a three day reversal pattern, in the blue box, which has since been followed by 4 days of higher highs and lows. Together with the much oversold indication on the Stochastic Oscillator, bottom chart, may lead to further price increases over the coming week or so. 

How to Trade

Buying options may be an ideal position when an outcome is unknown or if volatility is expected (which is common over FOMC meetings). This is because through buying an option your risk is limited and you cannot get stopped-out by large market swings; you are not required to place a wide stop-out to manage risk instead you pay a premium for the option upfront. The premium paid is your maximum exposure no matter the market move. The following provides two option trade examples.  

If you expect the Fed to keep interest rates on hold and their language will show probabilities of delays, then to take advantage of higher EUR/USD you may buy a Call option. A Call gives the right to buy at a certain level (strike) for a certain period of time. 
 
The image below is a trade setup on the ORE Web-Platform, it is a 3-day Call to buy 10,000 EUR at 1.1100 (as highlighted by the orange box). It costs a premium of 26.38 USD to buy this option which is also the maximum risk in the trade. If the EUR/USD rises above 1.11 by expiry, Friday at 14:00 GMT, the option will payout. If the pair does not rise then the option will lose by the premium (26.38 USD).



On the other hand, if you think the Euro rally may be over and Yellen’s speech on Wednesday may show signs on raising rates much sooner than later then to take advantage of a decreasing EUR/USD you may buy a Put option. A Put gives you the right to sell at a certain level (strike) for a certain period of time. 

The image below is a trade setup on the ORE Web-Platform, it is a 3-day Put to sell 10,000 EUR at 1.10 (as highlighted by the orange box). It costs a premium of 36.82 USD to buy this option, this is also the maximum risk in the trade. If the EUR/USD falls below 1.10 by expiry, Friday at 14:00 GMT, the option will payout. If the pair does not rise then the option will lose by the premium (36.82 USD).