FxWirePro: Deploy ‘Debit Call Spreads’ for USD/CAD With Deep In-The-Money Ahead of BoC in H2’2019

USDCAD minor trend looks to be little weaker in June so far, dipped from 1.3527 to the current 1.3160 levels or -2.17%. Further dips are foreseen as Bank of Canada is on the table for its monetary policy at the beginning of H2’2109 (scheduled on July 10th). But the major uptrend of the pair seems still robust as it does not seem as if the US Fed would lower its key rate corridor (at present 2¼% to 2½%) by 50bps at the end of July. Fed chair Jay Powell did not give a more urgent indication of rate cuts than last week at the FOMC press conference. Accordingly, we advocate a suitable options strategy to hedge the swings.

USDCAD OTC indications and options strategies: 

At spot reference: 1.3160 level while articulating, we advocate diagonal debit call options spreads foreseeing both mild downswings in the near-term and the major uptrend. Positively skewed IVs of 6m tenors are indicating upside risks with OTM bids up to 1.36 level. Bullish neutral risk reversal numbers substantiate this bullish stance coupled with 1m skews that are well-balanced on either side. 

Well, contemplating above driving forces and OTC updates, diagonal call spreads as preferred option structures seem the best suitable under prevailing circumstances given elevated skew and favorable cost reduction.

Execute USDCAD 3m/2w call spread strategy (strikes 1.3070/1.36) for a net debit. 

The rationale: 

Firstly, as you could observe the underlying spot of USDCAD has dipped below 1.32 level with bearish sentiments from 3-4 weeks or so, hedgers’ interests remained intact onto the bullish neutral risk reversals in longer tenors along with 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.

Favor 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% as shown in the above nutshell and shorting the upper leg call (OTM strikes) likely to reduce the cost of the ITM call by almost close to 20-25% as you could see skews of 2w tenors are well-balanced on either side. Source: JPM, Sentrix, & Saxobank

Currency Strength Index: FxWirePro's hourly CAD spot index is inching towards 14 levels (which is mildly bullish), USD is at -21 (mildly bearish), while articulating (at 09:33 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex