How to Trade a Range Bound GBP/USD and Breakouts...
Cable (GBP/USD) has been trading within a range for the past 3 weeks, between 1.5460 and 1.5640 (Blue box on chart). Next week however may create some turbulence as the Bank of England (BoE) will have its regular meeting to decide on interest rates and BoE Governor Carney is due to hold a press conference. Carney has previously said that interest rates can be expected to go up before the end of this year or beginning of the next, higher interest rates are bullish for the Pound. The BoE is not expected to do anything at this point, what will be very interesting is the inflation report, which should give clues as to how fast BoE may have to raise rates, higher inflation means interest rates will rise faster. Monday sees UK manufacturing Purchasing Managers Index (PMI) data released, which is an indicator of economic activity. This is an important piece of data given that manufacturing is such a large component of GDP, a number higher than 50 indicates an expanding economy which is bullish for the GBP, however what is important to look out for is a number that is different from expectations, forecast for Monday’s PMI is 51.4, same as the previous number. Construction PMI and Services PMI will be released on Tuesday and Wednesday, respectively, and a strong release above the 58 level forecasted may boost the Pound.
A look at the Technical's
Looking at the chart below we can see how a triangle pattern has formed, which started at the end of May and is outlined by the broken black line. The pair broke the triangle on the upside on 28th July, which is a bullish signal. Price action has been in a range for so long that for the bullish trend to be confirmed it needs to close above the 38.2 Fibonacci retracement line at 1.5641. For a downward trend to be signalled price would need to close below the 61.8% line at 1.5461.
Trading High Turbulence
If you think the inflation report will show signs of much higher inflation, and that PMI data releases will be much higher or lower than expected and therefore the market will react and Cable will move out of its range, i.e. an increase in volatility, then you may buy a straddle option strategy. This involves buying a Call option, which gives you the right to buy GBP/USD at a certain price over a certain period of time, and simultaneously you buy a Put option, which gives you the right to sell GBPUSD at a certain price, both with the same strike price and expiry date. If the price of cable moves, whether it is up or down, you may profit.
For example, the image below is a buy straddle with strike price at the market’s current levels, 1.5575, expiry of 1-week and each leg is for 10,000 GBP. It will cost 154 USD to buy this strategy (and this cost is your total investment size).
The Scenarios chart and table below shows the profit potential of this trade by expiry. The horizontal axis is the GBP/USD price and the vertical axis is the profit or loss. In the table, you can see that as long as the pair moves above 1.5729 or below 1.5421 (as highlighted by the blue box on the table) a profit will be made. However, if GBP/USD does not break-out of the range then a loss will be incurred. This loss is limited to the premium paid to buy the strategy (154 USD) and maximum loss will only be reached is Cable expires exactly at the strike rate (1.5575).
Trading the Range
If you think inflation will be low and PMI data will be more or less as expected and price action will not move very far in either direction, you may sell a straddle. This involves selling a Call and a Put option simultaneously with the same strike price and expiry date. If price does not move during the life of the options you will receive the value of the premiums. Note that this is the exact opposite position to buying a straddle.
For example, the image below is a sell straddle with strike 1.5575, expiry of 1-week and each leg is 10,000 GBP. You will receive 130 USD when selling this strategy.
The Scenarios chart and table shows that a profit will be made if GBP/USD expires inside the range 1.5444 to 1.5700, with maximum profit made if the pair expires at the 1.5575 strike (as highlighted by the blue box). However, if GBP/USD breaks-out of this range then a loss is incurred and to protect your maximum loss you must use a stop-loss order.
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