FxWirePro: Capitalize on USD/CAD Interim Dips, Short-Tenured Risks Reversals and 3m IVs to Optimize Hedging - Deploy Debit Call Spreads

CAD has continued to exhibit resilience despite a number of ups and downs in the global macro landscape in the second half of this year. Over that time, CAD trade weighted returns narrowly trail that of only JPY, CHF and USD – traditional anti-cyclical, safe-haven currencies that have benefited from significant flare-ups in the trade war.

Similarly, CAD has exhibited the narrowest spot range in G10 against the dollar since our last publication, despite the global rates rally and numerous new trade headlines to digest throughout the month (refer 1stchart). USDCAD has been dipping from ths week’s peaks of 1.3345 levels to the current 1.3275 levels amid major robust uptrend remains intact. We recommend below options strategy as these price dips can only be momentary as the major uptrend is most likely to resume.

Options Trades Recommendation: At spot reference: 1.3278 level while articulating, we advocate diagonal debit call options spreads foreseeing both mild downswings in the near-terms and the major uptrend. Positively skewed IVs of 3m tenors are also indicating upside risks with OTM bids up to 1.35 level.

While bullish neutral risk reversal numbers substantiate this bullish stance coupled with 1w RRs that are indicating the hedging setup for mild downside risks. 

Well, capitalizing prevailing price dips and OTC indications, diagonal call spreads are perceived to be preferred option structures that seem the best suitable under current circumstances given elevated skew and favourable cost reduction.

The Execution: USDCAD 3m/1w call spread strategy (strikes 1.3150/1.35) for a net debit. 

The rationale: Firstly, as you could observe the underlying spot of USDCAD has dipped somewhat in the minor trend below 1.33 level with exhausted bullish sentiments from recent past or so, hedgers’ interests remained intact onto the bullish neutral risk reversals in longer tenors along with shrinking IVs (implied volatilities).

Short calls are most likely to expire worthless, so that the option writer can be rest assured with the initial premiums received.

Secondly, One should understand the prime intricacy of choosing ITM call which is that such options with strike prices close to the price of the underlying spot tend to have the highest risk premium or time-value built into the option prices. This is compared to deep in the money options that have very little risk premium or time-value built into the option price.

Thereby, one can achieve hedging objective as the deep in the money call option with a very strong delta will move in tandem with the underlying spikes.

Favour optionality to directional trades. We are inclined to position for a directional call spreads, as calling the bottom is quite difficult and adding naked spot exposure is risky at the moment.

Maintain the net delta of the position above 70% and shorting the upper leg call (OTM strikes) likely to reduce the cost of the ITM call considerably. Source: Sentrix, JPM & Saxobank