May 2009

From time to time events unfold on the stage of history that drives market movement to extreme levels.  Extremes in the futures markets create rare opportunities for the perfect storm—a storm that has the power to generate exponential profits with limited risk exposure.  One such event has been taking shape for many months now.

With direct ties to short term interest rates, the Eurodollar has been making its’ move.  Recently the financial market that correlates with the 3-month Libor interest rate has gained momentum as the push through 99 basis points has come to fruition.  This week further explosive action moved the market closer to the 99 ½ area. 

What does this mean for investors?

Simply put, the closer to 100 basis points—the less risk exposure for short positions.

The Eurodollar represents the U.S. Dollar in countries outside the U.S.  Originally it was a dollar denominated deposit held in Europe, however, in modern day such deposits are held in many major countries around the globe.

Eurodollar prices can be very responsive to Federal Reserve policy and inflation.  Interest rates falling will cause the Eurodollar to rise in price, and rising rates cause the Eurodollar to fall.

Eurodollar Futures

One Eurodollar contract gives you control of $1 million Eurodollars, and reflects the Libor rate for a 3 month, $1 million dollar deposit. 

Eurodollar expirations are in March, June, September and December and are offered for trade almost 24 hours per day on the GLOBEX exchange.

Presently margin is $1,100 per contract.  1 point equals $25.  This gives us a highly leveraged position in the marketplace, and that’s what we love about commodity futures investing—small amounts of investment capital influencing massive amounts of marketplace money.

Using the example of 99 basis points, when the U.S. short term interest rate falls to a 1% yield the Eurodollar will typically trade around the 99 area.  100 minus a 1% yield equals 99 basis points.  This is the return investors can expect on deposits outside the country. 

100 basis points acts as a ceiling; if Eurodollars were to move above 100 this would be the equivalent of taking out a loan from your local bank and the bank paying you interest on the money they lent…of course this wouldn’t make much sense for the bank. 

As of this morning, May 22, 2009, risk to 100 per short contract amounts to less than $1,800.  This is truly a rare opportunity and will only become better if/when the market moves closer to 100. 

Velocity

Understanding the risk involved in any investment gives the trader a distinct advantage.  Depending on your allocation of investment capital and your risk tolerance a choice might be to begin putting on short positions now.
 

A consideration, though, is to consider the possibility of how long interest rates will stay this low and how long Eurodollars will remain in the higher ranges.  The fact that it’s nearing the upper range is, in my mind, not a strong enough reason to layer in short positions because of the possibility of the market remaining at this level for extended periods. 

Velocity on our investment capital is something worth being mindful of.

Tools for Timing

Watch the tools for confirmation of a trend reversal.  They can assist us in timing our entry efficiently and keep us from diving in too early. 

From a technical chartist’s point of view, the Eurodollar market can be traded using the tools and indicators in precisely the opposite way we use them in a bottom-side-up market. The difference is we’re trading top-side-down so use your tools and indicators the same way you would normally but in the opposite direction.

Awareness Creates Opportunity

Americans spend countless hours watching the evening news, reading the papers, and catching updates via the web.  But it’s our awareness of what is happening around us that opens the doors to potentiality in our lives.  Boundless profit opportunities come and go; they have been for many years and will continue. 

Will you take advantage of this wondrous profit opportunity or just wait for the next one?   Either way, at very least be sure to paper trade the Eurodollar market as this trade setup comes into play.  Then when history repeats itself, which it often does, you’ll be ready to fully benefit from its effects. 

To your success!

*More information and details of how to use the three distinct confirmation tools & indicators for efficient entry timing can be found in the book, CHARTSMITH—Forging Your Financial Future.