A Cheap and Easy Way to Speculate on a Yen Reversal
Nothing lasts forever, not even the bear market in the yen.
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The Japanese yen has been in a prolonged bear market. Seventeen years of wildly dovish Bank of Japan monetary policy has resulted in a 13-year bear market in the country’s currency. For the first time in almost two decades, the BOJ has taken steps toward normalizing interest rates by increasing its target short-term rate to 0.1%.
From a mathematical standpoint, this is a nothing burger. Still, from a psychological perspective, it could mark the beginning of the end of the carry trade that has dominated the global economic landscape for nearly the span of my brokerage career. The carry trade was to borrow money in one currency at a low interest rate and use it to make higher-interest investments in another currency (i.e., short the yen and buy the U.S. dollar).
Seasonality Soon Turns Bullish
Moore Research Center Incorporated compiled seasonal data over the past 30 years of yen trade. The result is a rather overwhelming tendency for the currency to weaken into early April, then rally through the summer. Of course, seasonals aren’t guaranteed, and markets often try to front-run them, which causes some distortion. Nevertheless, we have found seasonal analysis to be helpful when combined with other practices.
Speculators Are Holding Historically Large Short Positions
The Commitments of Traders Report (COT) issued by the CFTC (Commodity Futures Trading Commission) depicts an overcrowded short position in the yen. Historically, similarly bearish speculative bets have had various outcomes.
In 2007, the unwinding of the short position resulted in a monumental rally, on most other occasions, it merely staved off additional selling. However, we noticed that the modus operandi in the yen has been a double bottom while the bears are over their skis, followed by a sizable rally. We believe a repeat is near. A “2007-type” rally might be out of reach, but a 2016-style run is probable.
A Cheap and Easy Way to Speculate on a Yen Reversal
The Japanese yen futures peaked at about 1.30 yen per dollar in 2011 (meaning it cost about 1.3 cents to buy a single Yen); 13 years later, it is trading at about 0.0066 (one Yen can be bought for under 0.7 cents in the U.S. currency). We could see a violent move toward mean reversion if the tide turns. Thus, we like the idea of having a foot in the door.
Speculators with access to a futures account can purchase December yen 7400 call options for less than $750. This represents a position with 262 days in the market with the risk limited to the cost of entry and theoretically unlimited profit potential.
A lot can happen between now and the currency option expiration on December 6. There is a U.S. election season, several Federal Reserve decisions, and an ample opportunity for unforeseen events to emerge.
