FxWirePro: Driving Forces of USD/CAD Bullish/Bearish Scenarios, Options Sensitivity Tools and Hedging Strategies

USDCAD bullish scenarios above 1.37 if:

1) NAFTA withdrawal; 

2) Canadian growth slowdown extends vis-à-vis US; 

3) Local/global oil prices weaken despite cutbacks 

4) Political crisis worsens 

USDCAD bearish scenarios below 1.28 if:

1) USMCA ratified ahead of schedule; 

2) BoC reverts to hawkish rate path;

3) A broad US dollar discount returns because of political risks.

The US relative growth outperformance comparatively persisting, but it would appear that this growth differential is currently being somewhat discounted in rates markets (refer 1st chart). Should this relative outperformance continue, a re-widening of US- CA spreads may be justified, and would be supportive of USDCAD higher.

USDCAD OTC indications and options strategies: 

At spot reference: 1.3483 level, we advocate diagonal call options spreads foreseeing both mild abrupt downswings in the near-term and the major uptrend. 

Contemplating above driving forces, diagonal call spreads as preferred option structures seem the most suitable in prevailing circumstances given elevated skew and favorable cost reduction.

At spot reference: 1.3270 levels, we execute USDCAD 3m/2w call spread with strikes of 1.3250/1.36 for a net debit. 

The rationale: As you could observe the underlying spot of USDCAD has dipped below 1.34 level with bearish sentiments from two months, hedgers’ interests turned onto the negative shift in risk reversals in shorter 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.

3M ATM IVs are trading between 5.34% - 5.73%, positively skews are also suggesting the odds on OTM call strikes up to 1.37 levels at this juncture. Please notice bullish neutral risk reversals that signal upside risks in the risk-neutral distribution of returns. Also, the IV curve is at, or slightly decreasing, with maturity.

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.

Maximum gain is achievable when underlying spot FX move above OTM strike with ideal risk-reward.

By shorting the out-of-the-money call, the options trader finances the cost of establishing the bullish position but forgoes the chance of making a large profit in the event that the underlying asset price skyrockets. Source: JPM, Sentrix, & Saxobank

Currency Strength Index: FxWirePro's hourly CAD spot index is flashing at -2 levels (which is neutral), hourly USD spot index was at 120 (highly bullish) while articulating at (10:56 GMT). 

The above indices are also conducive for this strategy.

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