Amid speculation regarding the United States Federal Reserve’s timetable for its quantitative easing rollback schedule, nearly all dollar-based currency futures trades have moved in tandem with the expected and realized effects of economic data releases on Fed Chairman Ben Bernanke’s economic outlook. Although the relative strength of the Canadian dollar is traditionally linked with the price of crude oil, the commodity’s strong performance has done little to trump the waxing strength of the greenback in recent weeks, and with domestic issues mounting the justification for the current level of the Loonie has become increasingly uncertain.
The Canadian dollar has been in near-continuous decline since mid- to late-September 2012, although at its current level it is still well above its pre-recession valuation. The Canadian financial system was largely insulated against those investment instruments that dealt a deathblow to so many American institutions, but in many ways Canada seems to have slumped into a similar (though far better understood and notably better-controlled) situation as to that which brought the American system to its knees. Canadian household debt to GDP has reached 94.5% and has continued to trend higher over time, and many have grown wary of the still-skyrocketing housing market (although government mortgage insurance in Canada is far more robust than that in the United States). Though none of these issues have yet reached crisis levels, each has undoubtedly contributed to the currency’s slump.
Although oil production levels are continuing to increase in Canada, the fact that climbing oil prices have done little to help prop up the Canadian dollar in the face of present domestic and dollar-relativity concerns shows that the Bank of Canada will likely find that it needs to act in an effort to balance the housing market while accommodating other domestic industries, and that the date of the U.S. Fed’s taper draws nigh.
With these near term pressures likely to weigh down the Canadian dollar we can set up an options trade that offers us a great risk vs. reward setup. With September Canadian Dollar futures trading around 0.9700 we can use the options market to project a downside target for September expiration. The options market is implying a move of 0.0185 by expiration, so this gives us a downside target around 0.9515. With this target we can look to set up an options trade.
Trade: Buying the 6C Sep 0.96-.095 Put Spread for $0.002
Risk: $200 per 1 lot
Reward: $800 per 1 lot
This trade sets up for a 4-1 reward to risk ratio if Canadian Dollar futures trade below 0.95 on September expiration.