FxWirePro: USD/CAD ITM Puts Fairly Suitable For Both Trading And Hedging

The USD rebound extended to the 1.3030 area yesterday, about where we think the short-term USD consolidation should run out of steam. 

Soft trade data for November sustain the weak Q4 GDP outlook—Scotiabank Economics’ GDP Nowcast is tracking growth of virtually zero for the quarter currently, versus the BoC’s forecast of 1.3% in the last MPR. This is an important benchmark for policy makers and it remains to be seen whether BoC Gov Poloz remains as sanguine on the outlook in tomorrow’s comments from Vancouver as he was in Dec. 

For now, we think CAD-supportive spreads and relatively firm crude prices can keep the USD advance in check certainly in the medium run. A dovish tilt to the governor’s comments tomorrow is a risk for the CAD, however.

Despite our expectations that Canada loses its cyclical exceptionalism and CAD unwinds some of its outperformance, the resulting currency weakness will be only modest, rather than large and broad. 

Trading and Hedging Strategy: 

Considering above underlying factors, we advocate 1% in the money put options of 2m tenors that seems to be the best suitable on hedging as well as trading grounds.

The rationale: USDCAD closed out 2019 on the defensive and made a crucial weekly/monthly close below long-term support zone of (1.2950 – 1.3165) drawn off the 2015-17 support zone for the USD on the longer run charts.

Although the pair has been attempting show some minor rallies from last 2-3 days, it is unwise to buck the major trend, interim rallies in the minor trend may be deceptive, and hence, we’ve considered ITM put options capitalizing on some driving forces. Below are the key factors listed out that drives us to prefer these derivatives instruments:

1) The bullish neutral risk reversal numbers indicate the inertia in hedging sentiments, while the underlying spot has been bearish (refer 1st chart).

2) While the positively skewed IVs of 3m tenors are indicating both the downside as well as upside risks (refer 2nd chart).

3) Please be noted that the payoff structure is quite handsome as it dips below 1.30 (BEP) (refer 3rd chart), hence, it is suitable for trading purpose also. 

4) These ITM puts (2m) are fairly priced-in as they trading at CAD 1799, whereas Net Present Value (NPV) of these options are just 1713 which means they are trading at just shy above 5% and the IVs of 2m tenors are oscillating between 4.5 – 4.75% (refer 4th chart). Courtesy: Ore, Sentry, & Saxobank