FxWirePro: Spotlight On Canadian GDP Data - Deploy CAD/JPY Options Strips To Hedge

Canadian growth data announcement is scheduled today, the Canadian economy advanced 0.1 percent on quarter in the three months to December 2019, easing from a 0.3 percent expansion in the previous period. It was the weakest growth rate since Q2 2016, when the economy shrank 0.5 percent, amid several factors including pipeline shutdowns, unfavourable harvest conditions, rail transportation strikes and impacts from the United Auto Workers' strike in the US.

Canada’s balance of payments setup remains among the worst in G10 (refer 1st chart), and lower rates will make satisfying external financing requirements even more difficult. CAD may be forced to depreciate much more if short-term capital inflows slow. Canada has consistently run an FDI deficit, meaning that most of the C/A deficit over the last decade has needed to be over-financed by portfolio inflows (predominantly bonds).

Despite this recent beta-driven CAD strength, the view for underperformance in 2020 on domestic factor still holds amid pandemic Covid-19, though may be less front-loaded than originally expected. This view has been predicated on an expected dovish BoC responding to a broadly-weaker economy, potentially forced to ‘catch up’ to other central banks globally, having earlier eschewed rate cuts in 2019, thereby warranting some catch-up CAD weakness.

OTC Updates and Options Strategy: 

The positively skewed CADJPY IVs of 6m tenors have still been signaling bearish risks, the hedgers’ interests to bids for OTM put strikes up to 75 levels indicating downside risks in the medium terms (refer 2ndexhibit). 

Accordingly, we advocated diagonal options strips strategy to address any abrupt upswings in short-run and the major downtrend.

At spot reference: 77.800 level, buying 2 lots of 3m at the money delta put option and simultaneously, buy at the money delta call options of 1m tenor. It involves buying a number of ATM call and double the number of puts. The option strip is more of customized version of options combination and more bearish version of the common straddle. 

Any hedger or trader who believes the underlying currency is more likely to spike upwards in short run but major downtrend can go for this strategy. Cost of hedging would be Net Premium Paid + brokerage/commission paid. Courtesy: Sentry & JPM