Short-term U.S. dollar/Canadian dollar implied volatility jumped last week as investors bought at-the-money straddles while the Canadian dollar strengthened against the greenback. One-week implied vol spiked to 7.75% from 7% and one-month implied vol rose to 7.75% from 7.2%, which traders described as a big move for the currency pair. Investors bought at-the-money straddles in which they purchased a Canadian dollar call/dollar put and bought a Canadian dollar put/dollar call as the Canadian dollar strengthened from CAD1.44 on Monday to CAD1.4210 Thursday.
Traders said this is a typical trade to achieve a long gamma position---or the change in the spot level. An investor would hedge this position by delta hedging, or selling or buying Canadian dollars in the spot market. One analyst said investors could have bought straddles to allow them to have some protection in the options market while trading spot directionally.
Shahab Jalinoos, foreign exchange strategist at UBS Warburg in London, explained that the Canadian dollar has strengthened recently because Canadian growth is outstripping U.S. growth and the Bank of Canada raised interest rates in April. In addition, the central bank has indicated that it will not resist a strong Canadian dollar. "The SARS outbreak has been the only disruption," Jalinoos added, explaining that the currency has strengthened in a linear fashion since the beginning of the year from CAD1.58. He predicted it would continue to strengthen through CAD1.40 because fundamentally the Canadian currency has been playing catch up against the dollar.
