FxWirePro: Loonie vulnerable on NewFTA or NoFTA as Trump dissatisfied with NAFTA developments – Take a look on vol pricing in USDCAD options

Not just Powell but also Canadian trade policies were at the receiving end of the US President’s wrath yesterday. Trump declined a meeting with the Canadian Prime Minister Justin Trudeau and said he was “unhappy” about the progress of the NAFTA renegotiations and about the Canadian trade delegation. If these were stringent signals about the progress of the negotiations, then the trade agreement is never going to happen. 

As a result, CAD has been easing off considerably from last couple of days and USDCAD is trading well above 1.30 levels. But on the flip side, who wants to exclude that Trump changes his mind tomorrow? NAFTA negotiations will not essentially result in one of a discrete set of outcomes, and so we focus on boundary scenarios of best-case NewFTA (contracted and approved), and worst-case NoFTA (with an actualized US pull-out).

But the best-case NewFTA would justify USDCAD at 1.24, as pent-up deferred investment drives a repricing of monetary policy to catch up with the Fed, and short CAD hedges are unwound.

The worst-case NoFTA could mean USDCAD at 1.43, as market prices a "safety-net" 50bp cut by BoC, much like was delivered in 2015 in response to a somewhat similar negative sectoral shock to help stabilize and encourage required economic rebalancing. A potential overshoot would also probably be unbound and thus larger versus the best-case scenario, given the large unknown unknowns from such an unprecedented scenario. This is also mirrored by fatter right-hand side tails in FX Vol pricing. 


While the razor-sharp focus of overnight forward vols can be fathomed to struggle capturing loosely timed NAFTA risks it is unusual to find the current level of complacency toward it in longer dated 3M (and similarly 6M) USDCAD options. 

Namely, at 1 sigma cheap, 3M USDCAD convexity (gauged as a ratio of 25 delta wings vols and ATM vols) is off the June low but remains well below levels seen during the oil price collapse in late 2014 and since late August has been back to near the multi-year low.

Hence, contemplating all the above scenarios, capitalising prevailing rallies, decide to initiate below options strategy.

Yes, bull put spread for net credits, so short 1W (-1%) in the money put with positive theta if you expect that USDCAD will spike up moderately over the next near future but certainly not beyond your imagination, simultaneously, go long in at the money -0.5 delta put option of 3w expiries with a view to arrest abrupt downside risks. 

Please be noted that the put you buy has to be at the money and the put you short has to be in the money with an anticipation of USDCAD could rise and remain unchanged within shorter expiration, and there onwards any fall below current spot FX would be taken care by longs in ATM put and also if you have any active longs in spot FX would be protected. 

Maximum profit: The initial credit received for this trade which is certain, after 1W if it continues its bearish business cash flows would be exponential, otherwise, hold long leg on hedging grounds.
The maximum risk is the difference between the two strike prices, minus the credit you received. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly CAD spot index is inching towards -116 levels (which is bearish), while hourly USD spot index was at 119 (bullish) while articulating (at 12:04 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex