AUDCAD 6M vols appear decent buys given their depressed levels (not far from 2014 lows) and the uber flatness of the 3M-6M vol curve.

Realized vols are not stellar however in a dollar-centric environment; hence theta bleed on vol longs is best avoided via forward volatility (FVA) structures.

So, opening positions in OTM AUD puts/CAD calls to monetize a potential correction lower in the cross is the clean directional play; one can, for instance, consider buying 6M 0.91 AUD puts/CAD calls with leverage in excess of 5:1 as a medium-term bearish play, where the admittedly distant barrier (8% OTMS) is still within the realm of possibility, having been breached only last September after the CNY devaluation.

Alternatively, relative value constructs involving buying AUD puts/CAD calls vs. selling USD puts/CAD calls (live, no delta-hedge) appeal as low cost ways of assuming exposure to the same directional dynamic.

The above chart demonstrates that OTM AUD puts/CAD calls are historically cheap and discounted in vol (and premium for the same delta) relative to OTM USD puts/CAD calls, which is odd because their spread behaves like an anti-risk asset by virtue of effectively being short AUD/USD delta, and hence ought to command a net positive premium.

Cumulative P/Ls from owning 6M 25D AUD put / CAD call – 6M 25D USD put/CAD call option spreads (bp CAD), and 6M 25D AUD puts/USD calls.

All options live (not delta-hedged) and rolled into fresh strikes monthly. Shaded bars represent vol spike episodes. No transaction costs

The anti-risk nature of the AUDCAD – USDCAD option spread: it essentially mimics returns from an equivalent tenor/delta AUD put/USD call – but at a fraction of the cost of the latter and with outperformance in periods of calm when time decay is a drag on the latter.

The risk to the spread is evidently a major USD sell-off that hurts USD/CAD significantly more; the working assumptions are:

(a) This is unlikely to materialize in the lead up to the December FOMC; and (b) the risk of an upward drift in G3 rates poses upside risk for the greenback against lower quality EM FX that should keep a lid on large scale dollar washouts.

From a trade structuring standpoint, we also create some cushion against USD declines by striking options meaningfully out of the money (25D) such that local, small scale dollar weakness has low odds of filtering through to terminal option returns.