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We all know that there exists the positive correlation between CAD and crude oil prices, this week’s report was bearish for crude but bullish for gasoline and distillate. Total commercial crude and refined product stocks drew by a combined 12.2 Mb; this was led by gasoline and distillate stocks falling by a combined 10.7 Mb.
Moving to global oil markets, Brent backwardation continues to indicate tightness in sweet crude. However, US sweet crude exports (of 1.92 Mb/d last week and 1.74 Mb/d in the last 4 weeks) continue at high levels.
Oil prices now probably discount a full nine-month extension to OPEC cuts. Using current option pricing as indicative of market consensus suggests that the market currently ascribes a roughly one in three chance (33% to be more precise) for Brent prices averaging $50/bbl or below in December 2018.
Please be noted that the positively skewed IVs of 3m tenors are well balanced and stretched on both OTM call and put strikes. While risks reversals of this tenor are indicating bullish risks owing to the above stated crude price risks.
Thus, we advocate buying USDCAD 3m risk reversal strikes 1.3440/1.2450 (at spot ref: 1.2880).
The recommended skews and risk reversal structure (refer above nutshells) takes direct advantage of the cheap skew opportunity.
It is expected that any CAD downside to be volatile, as it would likely be caused by geopolitical tensions and/or market unwind. This justifies owning topside convexity and volatility.
Pure volatility investors may implement active delta-hedging to get direct exposure to the skew while getting rid of the directional risk.
Given the downside risks attached to CAD appreciation, we would advise directional investors to implement a delta-hedging strategy involving a negative pre-defined mark-to-market threshold.
Risk profiling: Unlimited below 1.2450, investors face unlimited risk if USDCAD trades below the 1.2450 strike in three months.
Currency Strength Index: FxWirePro's hourly USD spot index has turned into 168 (which is highly bullish), while hourly CAD spot index was at shy above -81 (bearish) at 07:19 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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