FxWirePro: BoJ keeps CAD/JPY on check - option strips to hedge both bearish/bullish scenarios in major trend

CADJPY is perceived to be edgy and it seems to be at undervalued levels by the commitment of the BOJ to target a 2% inflation rate and anchor bond yields. We see only a small chance of that commitment waning in 2018 because the inflation rate won’t get anywhere near 2%, but the net result is a huge skew in the range of outcomes for the CADJPY.

From last three-four weeks, the prices of this underlying pair have been oscillating between 89.806 and 87.457 levels with more potential on the downside.

Technically, current week prices are attempting breach below 21EMA levels (i.e. 88.1685 levels) and head towards wedge baseline, thereby, one could expect more slumps as both the leading oscillators have been constantly converging downwards to signal weakness (refer weekly chart).

The bearish CADJPY scenario below 84.500 driven by:

1) The US moves ahead on border adjustments or NAFTA negotiations turn sour;

2) Commodity prices fall much further on China/global growth concerns;

The bullish CADJPY scenario above 89.1924 driven by:

1) Global demand pushes oil prices well above $60.

CADJPY is one of the better candidates since recent CAD weakness has undershot recent moves in oil and rate spreads.

Hedging Strategy: Option strips (CADJPY)

Please be noted that the positively skewed ATM IVs of 3m tenors indicate the hedging interests of OTM put strikes upto 85.50 levels.

To factor-in above stated driving forces, we reckon that the underlying pair has equal chances of moving on either side but with more potential on downside, accordingly, it is wise to initiate longs in 2 lots of 3m ATM -0.49 delta puts, simultaneously, add long in 1 lot of +0.51 delta call of the same expiry, the payoff function of the strategy is likely to derive positive cashflows regardless of swings but more potential from the underlying spot FX moves towards downside.

The risk is limited to the extent of the premium paid to buy the options.
The reward is unlimited until the expiry of the option.

Please note that the trader can still make money even if he was wrong, that means the strategy likely to derive handsome yields in premiums regardless of swings. But the spot FX has to move in the opposite direction really fast. The 1 call bought has to beat the cost of buying all the options and still bring in some profits.

Currency Strength Index: FxWirePro's hourly CAD spot index is displaying shy above 0 levels (neutral), while hourly JPY spot index was inching higher towards 119 (bullish) while articulating (at 06:43GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

As you could see bullish interest in JPY, the bears of this pair are most likely to extend slumps upon our above stated technical rationale.

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