Tags: australia | Profit | down | Under

Profit From the Woes Down Under

Wednesday, 06 Jun 2012 08:30 AM

By Ashish Advani

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I want discuss Australia. Mind you, it would take some amount of guts today to invest in anything Australian. When the masses are running and there is blood in the streets, it is probably the best time to actually take a position in the trade.

As we have known, Australia has become almost a proxy to the China growth story.

For nearly a decade, Australia has served as the resource bowl to China. It has been supplying a bulk of the natural resources that China needs to grow.

We have seen significant companies like Rio Tinto, BHP Billiton, National Australian Bank (NAB), etc have been paving the way and contributing heavily to China’s success.

I started investing in the Australian dollars (AUD) back when it was worth 68 cents to US$1. It has not only appreciated significantly since then, but has yielded me over 4 percent return consistently along the way. This particular investment has paid of handsomely for me in the past few years.

Recently, the AUD hit is peak when it reached 1.09 AUD to 1 U.S. Dollar.

After a serious run when it went well past parity to the U.S. dollar in 2010; a run that has been ongoing for five years, it has finally taken a breather.

The recent rush to safety due to the European debt crisis as well as the slowdown in global growth has taken a deep toll on the Australian dollar. It has dropped from its loft heights of 1.09 to 0.96. That is a significant drop in value.

What also prompted me to discuss the AUD is the number of short contracts against the AUD. Short contracts refer to the number of trades that are outstanding that are expecting the AUD to decline from here. The number of contracts are about 35,500, which is an all time high.

Frankly, speaking as a trader, this trade is crowded and the technical indicators are beginning to flash "deeply oversold." There are too many people betting on the AUD to decline further.

While it would be gutsy to go against the tide, a smart investor will buy time as he bets on a trade for the AUD to go back up. The smart money will be to buy a long-term AUD option deep in the money and bet on the AUD being at parity or higher about eight months to a year out.

Given that the current crisis will get resolved (Greece will leave the euro or not, Spain banks will survive or not – within a year), we will see the recovery of growth in China and we will see a resurgence of the AUD long before then.

With everyone betting against the AUD, the volatility for AUD calls is quite attractive now and by going deep in the money, we will reduce the time value of the option significantly.

Mind you, this is a speculative trade and will require a strong stomach to sustain the ride from here on.

The advantage of buying an option is you know what you will pay for this option and that is the absolute maximum that you will risk for this trade.

I feel certain that this is a winning trade on the AUD for the upcoming six months.

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