The Australian Dollar has been in a clear down trend since it peaked at 1.1090 in July 2011, recently touching levels not seen for the past six years, see chart below. The Aussie’s depreciation may come down to two factors; a weakening economy and falling commodity prices.
Australia's economy largely relies on exporting commodities such as gold. As commodity prices are quoted in USD and they have been falling across the board, one way for the Australian Government to protect producers of these commodities against falling prices is to allow AUD to depreciate. For example, when an ounce of gold depreciates from $1600 to $1200 they can make-up for it if AUD depreciates against the USD, from AUD/USD 1.1000 to 0.7500, because it maintains the value of Gold in AUD terms. (As 1 ounce of Gold goes from $1600/1.1000 = 1454.50 AUD to $1200/0.7500 = 1600 AUD).
The Australian Government faced a shrinking economy in 2008 and started to take measures to stimulate the economy. One of those measures was to reduce interest rates and 10yr yields on Australian Government bonds went from a high of 6%, in September 2009, to a current level of 3.08%. Falling interest rates will weaken a currency as investors will favour holding a currency that pays a higher rate, helping devalue the AUD to allow for more exports and as mentioned to help protect Australian commodity producers keep their profits in the face of falling commodity prices.
To help stimulate the economy, money supply was increased from AUD 50 Billion in late 2009 to over AUD 90 Billion as of July 2015, with the sharpest increases occurring towards the end of 2013 (see chart below). Such a stimulus also leads to falling interest rates, central bank rates are at a record low of 2% putting downward pressure on the exchange rate.
General economic data coming out of Australia has been weak also during the past month, with highlights on the Manufacturing Index which was released on July 1st at 44.2%, a number below 50% represents a shrinking economy.
Getting involved
Throughout this period many traders may have been able to take advantage of this trend by buying Puts on AUD/USD, which give you the right, but not the obligation to sell AUD and buy USD at a specified price (strike price) at a future date.If you have the view that the AUD will continue to fall over the coming weeks against the green back then you may buy a Put option. For example, if you expect the pair to move below 0.7400 in the coming weeks, then you may choose a strike of 0.7400.
The image below gives an example of a Put option with strike 0.7400, expiry 2 weeks for an amount of 100,000 AUD. It will cost 422 USD to buy the option. 422 USD is also your maximum risk.
You can check how the option would behave if the market were to continue falling, what the profit/loss would be for each AUD/USD price level, by clicking on the Scenarios button. The image below shows an example of profit/loss scenarios at the options expiry. If, by expiry, AUD/USD is trading at 0.7315 the option would return 100% profit, if AUD/USD is trading at 0.7400 or above the option would lose the maximum amount of 422 USD.
On the other-hand, if you expect AUD/USD to rise from its lows, you may buy a Call option. A Call option's value increases as the underlying market rises. The below image gives an example of a Call with strike 0.7600 and expiry 2 weeks, i.e. you may buy this options if you expect AUD/USD to rise above 0.7600 in the next 2 weeks. It costs 443 USD to buy this option. You may click ‘Scenarios’ to view the potential profit or loss.
The content provided is made available to you by ORE Tech Ltd for educational purposes only, and does not constitute any recommendation and/or proposal regarding the performance and/or avoidance of any transaction (whether financial or not), and does not provide or intend to provide any basis of assumption and/or reliance to any such transaction.
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