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Can the US dollar recover and have stock's following\?

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Yesterday's Treasury bond action was interesting as various pieces of economic data were released at different times during the trading day. Some work I did last night has me now firmly believing that stock price action is most likely going to be tied to what the US dollar does from here.

The US Dollar Index (dx00y) is a is a trade-weighted geometric average of six foreign currencies (Euro, Japan/Yen, Britain/Pound, Canada/$, Sweden/Krona and Switzerland/Franc).

Today's currency action has the US Dollar still showing weakness against this basket of currencies and now tests it lows dating back to December 2000. A break much below the 108 level might be a stock market action point for selling to be correlated against and trader/investors should be on the alert here. A rebound in the US$ from current levels could have stocks rallying as near- term currency fears could be lifted.

US Dollar Index Chart - Weekly Interval

The US dollar continues to weaken today and this is putting pressure on stocks. We must also understand that today is "triple-witching" expiration and will have some impact on how stocks trade, but that is much more difficult to analyze as we can see stocks pushed around based on various open interest levels as institutions will adjust positions on many of the option-related hedges they had put on to protect underlying equity positions.

However, near-term, traders should keep a very close eye on the US$. I think a break much below the 108 level on the above chart could see selling pick up in stocks. It is becoming increasingly apparent to me that stock market action is now being more driven by currency action than any other relationship in the market.

Should the US$ find buyers and see some profits taken from other currency gains around the world, then US stock markets may indeed rally.

Right now, an options trader, would be well suited to put on some "straddle" or "strangle" trades in the options market, as a break in currency (up or down) could be a market moving event.

However, it should be noted that the Market Volatility Index (VIX.X) 32.11 -1.2% is at a relatively high level, and option premiums are running high. Also impacting option premiums is the fact that were are right at an option expiration point (triple- witching) and that has premiums higher yet.

The "best" places to be looking for "straddle" or "strangle" trades would most likely be NYSE listed stocks, that have historically lower volatility, but would make sharp moves based on the currency fluctuations, which may trigger broader market action.

Trader's may want to visit the "Combination" section of OptionInvestor.com for a list of potential "straddle" or "strangle" candidates.

One sector that I would think would benefit further to the bullish side from a weakening US$ would be the Gold/Silver Index (XAU.X) 79.08 +0.29% and stocks within the precious metals category.

Jeff Bailey
Senior Market Technician
Option Investor

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