FxWirePro: A Glimpse at EUR/CAD Optionality – Deploy 3-Way Straddles To Hedge Puzzling Swings Ahead of BoC

EURCAD can’t hold gains above 1.4750 and may revert to range trade. The pair’s stealthy gains have come to a not so stealthy end, at least for now. We noted the rise in the cross would perhaps need to trade through 1.4750 in order to signal a break out but the EUR failed to hold on to Thursday’s rise through the mid 1.47 area and closed out the day (and the week) looking weak. One can make out that the pair has shown huge volatility but edging higher towards 1.50 areas, it has been oscillating between channle lines (refer above price chart).

In the Euro area, this week’s flash manufacturing PMIs saw a stronger than expected increase along with an improvement in the new orders-to-inventory ratio. While the level remains weak, there are some signs of encouragement from manufacturing. The final 3Q19 GDP print for Germany also showed that the weakness in growth is largely attributable to a drag from inventories, which should be supportive of growth in coming quarters.

Because of the comatose state of currency markets at present, CAD option risk premia appear oblivious to the fallout of this high stakes standoff. EURCAD risk-reversals in particular appear too complacently priced: at zero across the curve, they are well discounted to already low USDCAD risk-reversals (3M 0.35, 1Y 0.7), and under-priced relative to even tepid recent realized spot- vol correlations (SABR implied 6M spot-vol corr. in EURCAD r/r 1% vs. trailing 1-mo spot-vol corr 15%). 

BoC monetary policy is scheduled for the next week and they are most likely to maintain status quo.

While positively skewed IVs of EURCAD have also been stretched on either side, both OTM Calls and OTM puts are on equal demand (refer above nutshell).

Hence, 3-way options straddle seems to be the most suitable strategy for EURCAD contemplating some OTC sentiments and geopolitical aspects.

You see any fresh positive bids in EURCAD risk reversals to the prevailing condition, it should not be perceived as the bearish scenario changer, nor uptrend continuation. Instead, below options strategy could be deployed amid such topsy-turvy outlook.

Options strategy: Keeping above seesaw geopolitical and hedging sentiments under consideration, 3-way straddles versus ITM calls are advocated, the strategy comprises of at the money +0.51 delta call and at the money -0.49 delta put options of 1m tenors, simultaneously, short ITM calls of 1w tenors. The strategy could be executed at net debit but with a reduced trading cost.

Hence, on hedging as well as trading grounds, initiate above positions with a view of arresting potential FX risks on either side but slightly favoring short-term bearish risks. Courtesy: Sentry