By Rick Pendergraft, Editor of Cabot Options Trader
From Cabot Wealth Advisory 12/27/10 Sign up for free Cabot Wealth Advisory e-newsletter
The PowerShares DB US Dollar Index Bullish Fund (UUP) is an exchange-traded fund (ETF) that goes up when the U.S. dollar moves higher against other currencies.
The U.S. dollar got beaten up pretty good from June through October 2010 as the economy struggled and domestic interest rates hit record lows. The dollar’s decline took UUP down to the 22 level for the third time since the ETF launched in early 2007. UUP has since turned higher and is trading just above 23.
It now looks as though UUP is headed up above 26 with a target of 26.50. If you buy the stock here and it goes up to 26.50, you would make just shy of 15%.
However, because the UUP is not very volatile, you can buy the June 21 Call for $2.28, or $228 per (100-share) contract. If UUP goes up to 26.50 as I expect it to, the June 21 Call will be worth at least $5.50 for a gain of 141%--almost 10 times greater than the gain you would get buying shares of UUP.
On the downside, I recommend exiting the trade on a close below 22. If shares decline below 22, the option should be worth approximately $1.10-$1.15, for a loss of around 50%. This gives a reward-to-risk-ratio of 2.82.
Here is the beauty of this trade. If you were to buy 1,000 shares of UUP, you would pay just over $23,000 at the current price. A 15% gain would net you $3,450.
But if you were to buy 10 of the June 21 strike calls, it will cost you $2,280 and a gain of 141% would give you a gain of $3,215. So the gain for the option is almost as much as the gain for the stock—but you are risking 90% less!
On the downside, if the stock drops from 23 to under 22 and you own 1,000 shares, you lose just over $1,000. If the option drops 50% because the stock drops under 22, you stand to lose $1,140.
So let’s look at the whole picture.
If you buy shares of UUP at 23 with a stop loss at 22 and shares rise 15%, you would invest $23,000 to make $3,450, with a downside risk of $1,100.
If you buy the option, you invest $2,280 with the opportunity to make $3,215 and the downside risk of $1,140.
This is the perfect situation to play a longer-term option.
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PowerShares DB US Dollar ETF (UUP): A good hedge against declining stock prices
By J. Royden Ward, Editor of Cabot Benjamin Graham Value Letter
From Cabot Wealth Advisory 3/25/10 Sign up for free Cabot Wealth Advisory e-newsletter
Another of my favorite areas to invest in to protect my profits and reduce my portfolio risk is an ETF that invests in the U.S. dollar. PowerShares DB U.S. Dollar ETF (UUP) is a good hedge against declining stock prices. UUP rose 10.1% during the recent bear market while the S&P plummeted 56.8%. UUP shares are less volatile than the stock market or gold, which is another plus.
PowerShares Deutsch Bank U.S. Dollar ETF seeks to track the price and yield performance of the Deutsche Bank Long U.S. Dollar Futures Index. This index is comprised solely of long futures contracts. The futures contract is designed to replicate the performance of the U.S. dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc. Total ETF expenses are 0.83% of total value, which is reasonable. UUP pays no dividend.
We follow the actions of hedge funds, because they invest trillions of dollars and can cause major fluctuations in the stock market and other financial markets. Hedge funds and other institutional investors have been selling dollars and buying stocks and commodities during the past several quarters. Sometime in the not too distant future, investors will begin to reverse these trades by buying U.S. dollars and selling stocks and commodities. Massive U.S. dollar buying will push the price of the U.S. dollar substantially higher, and UUP shares will rise, too.
UUP shares declined 18% during the nine months ended 12/1/09 but have increased 6% during the past two months. I believe the U.S. dollar will continue to rise. The U.S. economy will likely improve while some European and the Japanese economies stumble along. The purchase of UUP will neutralize the volatility of common stocks and will offer a hedge against a possible fall in stock and bond prices.
Conservative investors typically buy stocks and bonds. Bond and bond ETFs are usually another good way to hedge against stock market losses. However, bond prices are very high and could fall when U.S. interest rates begin to climb. I still hold some bond ETFs, but I am avoiding new bond ETF purchases. I prefer to buy gold and U.S. dollar ETFs in the current market environment.
Editor's Note: You can read more about conservative investing and get continuing coverage of PowerShares Deutsch Bank U.S. Dollar ETF in the Cabot Benjamin Graham Value Letter. Roy's Classic Benjamin Graham Value Model stocks have soared 86.4% during the past 12 months. And his ultra-conservative Wise Owl Model stocks have increased 58.4% during the past 12 months. Now that's impressive! Don't miss out on his next recommendations. Click here to get started.
J. Royden Ward
Editor of
Cabot Benjamin Graham Value Letter A lifelong investment professional, J. Royden Ward applies his 40 years of investment research, portfolio management, writing and publishing experience to his role as analyst and editor of
Cabot Benjamin Graham Value Letter, which is directed to long-term investors seeking a guide to profitable value investing based on the time-tested systems originally developed by Benjamin Graham, the Father of Value Investing. A second-generation disciple of Benjamin Graham, Roy in 1969 pioneered the development of a computerized model that applied the formulas developed by Graham using a unique ranking system. Today, Roy applies his system to two models in the
Value Letter.