FxWirePro: USD/CAD OTC setup and fundamental drivers for optimized hedging via collar spreads

In this write-up, writing exorbitant calls in collar spreads amid cautious bears has been emphasized.

Before that let’s have a glance through the shrinking IVs in USDCAD that are creeping up a tad below 7.4-7.38% for 1-3m tenors, the tepid implied volatilities of ATM contracts across all tenors are favorable for option writers.

Please be noted that the 1% OTM call of 1m tenor seems to be overpriced above 16%, whereas IVs are trading a shy above 7%. Hence, it is deemed as a disparity between option pricing and IVs.

While the risk reversals, for now, have been showing a negative shift from 1m-1y tenors, while long-term hedging sentiments have also been bidding for the negative shift in risk sentiments.

IVs fading towards 7% and below 7.5% for 1-6m tenors, the tepid IVs among G10 FX space appears to be conducive for writers of such exorbitant call options.

USDCAD can be seen below 1.2550 driven by:

1) BoC indicates the intention to normalize rates due to an improved global outlook.

2) Global demand pushes oil prices well above $60 and Canadian oil investment picks back up materially.

Please also be noted that the options with a higher IV cost more which is why in this case OTM puts have been preferred over ATM instruments. This is intuitive due to the higher likelihood of the market ‘swinging’ in your favor. If IV increases and you are holding an option, this is good.

On the flip side, when you write an option, the seller wants IV to remain lower level or to shrink so the premium also fades away.

Hence, if any OTM calls are overpriced as stated above, writing such calls are recommended in tepid IVs.

Considering above OTC market reasoning, amid prevailing uptrend we think downside risks can also not to be disregarded in the long term, as result we reckon deploying shorts in such exorbitant call options while initiating longs in ATM puts in our hedging strategies that seem worthwhile under the scenario of the underlying spot FX keeps dipping abruptly driven higher oil prices.

Currency Strength Index: FxWirePro's hourly USD spot index has shown -98 (which is bearish), while hourly CAD spot index was at -148 (highly bearish) while articulating at 11:04 GMT. For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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