FxWirePro: Trade “USD/CAD diagonal debit call spreads” as 1m RR evidences bullish hedging interests, IV skews towards OTM call strikes

Any rate hikes by the Fed or any hawkish statements are viewed as bearish for CAD, which struggles to compete with high-yield bearing assets in rising rate environments. USDCAD was almost unchanged at 1.3165.

Sentiment on the commodity currencies remained fragile amid lower crude prices on Tuesday, as global supply glut concerns overshadowed rumors of a potential agreement among exporters to freeze output.

1M ATM IVs are trading a shy above 15%, skews are suggesting the odds on OTM call strikes while formulating below option strategy for gold's uncertainty at this juncture.

Option strategy:

Favour optionality to directional trades. We are inclined to position for a partial retracement of the down move through call spreads, as calling the bottom is difficult and adding directional spot exposure is risky at the moment.

Call spreads are preferred to vanilla structures given elevated skew and favorable cost reduction.

Buy USDCAD 1w call spread with strikes of 1.3250-1.3083 for a net debit.

The net delta of the position should be around 44 (0.65 ITM strike = 71 delta) and selling the upper leg call (OTM strikes) likely to reduce the cost of the ITM call by almost close to 20-25%.

The Black-Scholes IV curve is asymmetric in the overall sample, displaying a rising pattern with moneyness, and 1W and 1M risk reversals are signaling a sharp upside risk in the risk-neutral distribution of returns. Also, the IV curve is at, or slightly decreasing, with maturity.

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 reduces 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.