FxWirePro: Activate and uphold USD/CAD/COP calendar straddles on Saudi-Canadian tussle

The Saudi government in the recent past, reminded its ambassador to Ottawa, barred Canada’s envoy from returning and placed a ban on new trade, disapproving Canada for urging the release of jailed rights activists. The dispute set to deter what is a modest bilateral trade relationship worth nearly $4 billion a year. Canadian exports to Saudi Arabia totalled about $1.12 billion in 2017, or 0.2 percent of the total value of Canadian exports.

It is unwise to disregard USDCAD wedged between the prevailing storm-cloud of US trade policy escalation and an otherwise constructive cyclical outlook that is still warranting gradual rate hikes. Well, as stated previously in one of our post, at present, if we focus on the EM space, two currencies stand out as alluring for shorting vol: COP and TWD.

The rationale behind the former RV trade, a combination of positive vol Carry combined with modest exposure to risk, is still valid.

Similar arguments hold for selling optionality on COP, with 2M implied vol 50% above realized vol and 1 sigma above its past year average value. Compared to Asia, two political events in Latam (general elections in Mexico on July 1 and Brazil on October 1) have contributed to pushing vols higher, amongst other exogenous factors; choosing a 2M maturity allows avoiding the risk of being short-Gamma around the Brazilian elections date, while benefiting from vol levels which remain elevated.

Also, given its natural exposure to commodities and trade tensions, USDCAD works nicely as a hedge against the Carry generator, short-vol leg. Also, while this is not JP Morgan central scenario, a further resumption of the long US dollar trend, which has come to a halt over the past month, would not leave the long/short trade overly exposed: 1Y betas of the two currencies against the DXY index are comparable (60%), whereas betas of the two vols against the VXY Index show more sensitivity for CAD than for COP (50% vs 1%).

Despite the wide trading costs and some capacity constraints for trading the USDCOP leg in large size, the trade has performed well historically and over the past year and particularly so during periods where realized vol spread has been 3 vols above implied vol spread (where it stands currently). 

We advocate buying 2M USDCAD straddles @6.65/6.9, $35 million notionals/short 2M USDCOP straddles @12.25/13.5, $25 million notionals, keep both legs delta-hedged. Courtesy: JPM

Let’s glance at the FxWirePro’s Currency Strength Index: FxWirePro's hourly USD spot index is at -38 (which is bearish), hourly CAD spot index was at tad below 41 (highly bullish), while articulating at 08:25 GMT. For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex