FxWirePro: Deploy Butterfly spreads to hedge CAD/JPY puzzling swings

Although recent improvement in the Canadian economic data, an annualized increase of 2.5% for Q3 2015 GDP versus the BoC's forecast of 1.5%, we do not expect the BoC to raise interest rates until Q3 2016 amidst evidence of a more sustained recovery in commodity prices and growth metrics. To boost up this stance, in a recent speech by BoC's Poloz, it was mentioned that the experience of the global financial crisis and subsequent Great Recession has led policy-makers to question some basic assumptions. Long-held beliefs about monetary policy no longer apply in today's global environment.

On the flip side, the BoJ is likely to stay on hold this time but 30 Oct a closer call and dependent on data and market trends. If the BoJ stays on hold this time, the impact on financial markets should be limited as expectations for easing will remain. We do not think the current yen's exchange rate have reached levels that require urgent monetary easing.

As stated in our earlier post, the time for Yen holding tight back again, all chances of Yen may look superior over Canadian dollar in medium term future but no dramatic differences in prices on either direction, thus we advise to hedge this pair with below recommendations.

Currently the pair is trading at 91.927 with volatility of ATM contracts marginally inching higher (at 12.5%), we had not expected this much of price bounces to be frank but this should not create any harm for our currency portfolio. We believe CAD's gain is majorly due to crude's strength.

Hence, the recommendation on buying (-1%) OTM -0.14 delta put while simultaneously shorting ATM put with similar expiries and buy (1%) ITM -0.84 delta put while simultaneously shorting another ATM put with similar expiries. This strategy is structured for a larger probability of earning a smaller but certain profit as CADJPY is perceived to have a low volatility.

The highest return for this strategy is achievable when the pair at expiration is equal to the strike price at which at the money options are sold. At this price, all the options expire worthless and the options trader gets to keep the entire net credit received when entering the trade as profit.