FxWirePro: Are you baffled between deceptive swings of AUD/CAD and tepid IV smiles? ‘Short Guts’ combinations to derive positive yields

Although the pair has been showing strength in recent times, bears are active crucial resistance at 0.9526 levels.

Last 2 months of declining rallies have halted after testing supports at 0.9331 levels and 1st week of June has been favouring bulls.

Ever since a hammer pattern occurred at 0.9375 levels, the daily RSI has been converging to the price rallies, while stochastic has been indecisive.

While 7DMA crosses over 21DMA which is signalling the chances of ongoing rallies to extend. However, this has been adverse in monthly terms (21DMA crosses over 7DMA).

1w ATM IVs of AUDCAD is a tad below 8%, and 7.81% for 1m tenors, taking this stabilized IV factor into consideration which is on the lower side, option writers are on competitive advantage.

At spot reference: 0.9475, so go short in 1m (1.5%) ITM calls and short in (1.5%) ITM puts of the same expiry.

If you have sold an option, it is bad. A seller wants IV to fall so the premium falls. You should also note short-dated options are less sensitive to IV, while long-dated are more sensitive.

The option price predictions are obtained from the predicted risk-neutral measure by effectively integrating it against the corresponding option payoffs.

The non-linear transformation between option prices and the risk-neutral parameters applied here is not arbitrary.

Most favourable scenario: On expiration, if AUDCAD oscillates between the strike prices 0.9617 and 0.9332, maximum gain for the short guts strategy is certain and limited to the extent of initial premiums received.

At this price, while both options expire in the money, they have lost all their time value. It is this loss in time value that the short guts strategy aims to capture as profit.

Adverse scenario: Adversely, large losses can be incurred when the underlying spot FX makes a huge move either upwards or downwards at expiration.