FxWirePro: USD/CAD OTC Indications and Options Strategy Ahead of US, Canadian Payroll data and BoC monetary policy

Markets await today’s key data, June’s labor market figures for the US and Canada. Yesterday’s non-manufacturing ISM fell to a nearly 2‑year low of 55.1 and ADP private payrolls missed expectations for a second month, coming in at 102k. The ADP’s correlation with official payrolls is not always exact, but investors will be watching for signs of a broader slowdown in the US economy.

While the CAD is entering Wednesday’s NA session with a modest gain and extending its recovery from Monday’s bearish turn. The near-term domestic risk lies with the 8:30 am ET release of international merchandise trade data for May. We note the potential for position squaring ahead of Thursday’s U.S. holiday and highlight the importance of Friday’s dual employment release. Fundamentals remain supportive and the CAD continues to trade well below our estimated equilibrium based on interest rate differentials and oil prices (USDCAD 1.2634). Yield spreads are testing fresh lows however measures of sentiment and positioning are mixed as the options market is showing a modest rise in the premium for protection against CAD weakness.

USDCAD minor trend continues to be little weaker in July so far, dipped from 1.3145 to the current 1.3075 levels or -0.10%. Further dips are foreseen as Bank of Canada is on the table for its monetary policy at the beginning of H2’2109 (scheduled on July 10th). But the major uptrend of the pair seems still robust as it does not seem as if the US Fed would lower its key rate corridor (at present 2¼% to 2½%) by 50bps at the end of July. Fed chair Jay Powell did not give a more urgent indication of rate cuts than last week at the FOMC press conference. Accordingly, we advocate a suitable options strategy to hedge the swings.

USDCAD OTC indications and options strategies: 

At spot reference: 1.3075 level while articulating, we advocate diagonal debit call options spreads foreseeing both mild downswings in the near-term and the major uptrend. Positively skewed IVs of 3m tenors are indicating upside risks with OTM bids up to 1.33 level. Bullish neutral risk reversal numbers substantiate this bullish stance coupled with 1m skews that are well-balanced on either side. 

Well, contemplating above driving forces and OTC updates, diagonal call spreads as preferred option structures seem the best suitable under prevailing circumstances given elevated skew and favorable cost reduction.

Execute USDCAD 3m/2w call spread strategy (strikes 1.3070/1.33) for a net debit. 

The rationale: 

Firstly, as you could observe the underlying spot of USDCAD has dipped below 1.3527 level with bearish sentiments from the last 1-month or so, hedgers’ interests remained intact onto the bullish neutral risk reversals in longer tenors along with shrinking IVs (implied volatilities).

Short calls are most likely to expire worthless so that the option writer can be rest assured with the initial premiums received.

Secondly, One should understand the prime intricacy of choosing ITM call which is that such options with strike prices close to the price of the underlying spot tend to have the highest risk premium or time-value built into the option prices. This is compared to deep in the money options that have very little risk premium or time-value built into the option price.

Thereby, one can achieve hedging objective as the deep in the money call option with a very strong delta will move in tandem with the underlying spikes.

Favor optionality to directional trades. We are inclined to position for a directional call spreads, as calling the bottom is quite difficult and adding naked spot exposure is risky at the moment.

Maintain the net delta of the position above 70% as shown in the above nutshell and shorting the upper leg call (OTM strikes) likely to reduce the cost of the ITM call by almost close to 20-25% as you could see skews of 2w tenors are well-balanced on either side. Source: JPM, Sentrix, & Saxobank

Currency Strength Index: FxWirePro's hourly CAD spot index is inching towards 14 levels (which is mildly bullish), USD is at -21 (mildly bearish), while articulating (at 09:33 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex