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FxWirePro: CAD/JPY Wedged Between Bulls and Bears Ahead of BoC And BoJ - Deploy Diagonal Options Strips To Hedge

There are much more interesting central bank decisions on the agenda this week than last’s week ECB non-event. The Fed and BoC, in particular, would be interesting. The little bit we heard from FOMC members last week was not exactly enlightening but the BoC kept maintaining ‘status quo’.

The CAD has made further progress against the major pairs, in fact, despite soft Retail Sales and Wholesale Trade data. The BoC Business Outlook Survey reflected a small uptick in business confidence and resolute optimism on future sales prospects, meanwhile.

While US/Canada data surprises have not shifted materially, the preponderance of positive key Canadian data releases recently supports the outlook for steady BoC policy, leaving yield spreads highly CAD-supportive. Equity market gains (and relaxed market volatility) have, meanwhile, undercut safe haven demand for the USD while crude price gains lifted Canadian terms of trade in Oct and underpinned CAD gains.

On the flip side, the BoJ seems unlikely to be completely idle. Indeed, we might well see some tweaks to the framework similar to the adjustments made in July 2018, which saw the introduction of forward guidance, a halving of the size of the balance of current accounts subject to the negative policy rate, and an amendment of the amounts of each type of ETF to be purchased. At a minimum this time around we expect a revision to the BoJ’s forward guidance, which for some time has stated that it “intends to maintain the current extremely low levels of short- and long-term interest rates, at least through spring 2020”. While JPY remains flat amid no major developments on the US-China front but the sentiment deteriorates on the reduced safe-haven demand.

Hence, CADJPY is wedged between bulls and bears but CAD has little upper hand in the minor trend ahead of BoC And BoJ monetary policies.

OTC Updates and Options Strategy: 

The positively skewed CADJPY IVs of 3m tenors have still been signaling bearish risks, the hedgers’ interests to bids for OTM put strikes up to 81.000 levels indicating downside risks in the medium terms (refer above chart). Please also observe above technical chart for the major downtrend and minor uptrend. Accordingly, we advocated options strips strategy to address any abrupt upswings in short-run and the major downtrend.

We’ve been firm to hold on to this strategy on both trading as well as hedging grounds, unlike spreads, combinations allow adding both calls and puts at a time in our strategy.

Buy 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. Please be noted that the option strip is more of customized version of options combination and more bearish version of the common straddle. 

Huge profits achievable with this strategy when the underlying currency exchange rate makes a strong move on either downwards or upwards at expiration, but greater gains to be made with a downward move in next 3-months’ time. 

Hence, 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: Sentrix

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