With all of the headlines and discussions about the re-ordering of global trade, the foreign exchange markets have been in the middle of the action of trade flows and positioning. The Canadian dollar is among those potentially most impacted by some of the early headlines, even though there is still uncertainty about what any final tariff structure will look like, what the size will be and what will be excluded. This means that the FX rates have become more disconnected from more traditional guidelines FX traders may use to determine which currencies look relatively more expensive. Consider the chart above, which plots the generic front month Canadian Dollar futures against the spread between U.S. and Canadian 10-year yields. Historically, these two series have shown a strong co-movement. However, since the April 2 Liberation Day, the lines have become disconnected. On this front, one could suggest that the CD1 futures look relatively overvalued vs. the interest rate differential. However, is this reflecting investor flight from U.S. assets as some posit, or the inability for leveraged investors to bring this apparent basis arbitrage back into line, as others suggest? Either way, it does point to the possibility of potential volatility in the CD1 markets because it is either extended and due for a pullback ‌ or heading into more uncharted territory.

Turning to some other traditional relationships that have driven CAD futures, I overlay the front month futures vs. the Bloomberg Commodity Index in the top chart. As a resource-rich country that is a large exporter of commodities such as oil, lumber and agriculture products, CAD futures are impacted by large trends in commodity prices, even if day-to-day moves are less impactful. Based on this relationship, one might suggest that the CAD futures had become disconnected from commodity prices late in 2024 and that there is scope for a continued move higher. In the bottom chart, I zero in on a specific commodity like lumber and see a traditional relationship of co-movement, which broke down starting last fall, suggesting that there could be more scope for upside in CAD futures. While interest rate differentials might suggest CAD is overvalued, the commodity markets appear to be suggesting the opposite: that there is more scope for a continued move higher.

Now let’s turn to the technical analysis charts. I prefer to use the Ichimoku charts because they show the regions where traders are long or short, depending on the time horizon. In the top chart, a daily cloud chart not only has price broken above the cloud, but so has the lagging span (red line). This is indicative of a breakout and a change in trend, which I can see developing as the cloud itself is beginning to head higher. While the RSI is inching into potentially overbought territory, this daily chart is technically bullish and might lead traders to position for more upside. However, now adding to the confusion in the CAD futures market, I turn to a weekly Ichimoku chart. In widening the horizon, the picture changes. On this view, the move higher in CAD is about to run into resistance in both price and on the lagging span. This would indicate more friction in markets and the possibility that longer term bears will defend these levels, bringing into question the breakout on daily charts.

With the potential for volatility in the futures markets, I now turn the options markets to get an understanding of how option traders may be viewing CAD markets. The top chart plots the realized volatility of CAD futures vs. the futures price itself. I do this to show that as the price of futures has moved higher, the realized volatility that traders experience is also moving higher. This brings in the possibility that traders will be more likely to want to own options as futures move higher than they might on downside moves, as higher futures prices beget higher volatility and lower futures prices have meant lower volatility.

The CVOL index in the bottom panel suggests some of the same. It shows where CAD vol is relative to other currency pairs and relative to its own time series history. Would it be a surprise that the picture is mixed? Relative to its own history, I see that CAD vol is in the top quartile of where it has been in the past year. However, when comparing it to other FX pairs, I see that the absolute level of CAD vol is the lowest of all the pairs on the list. It wouldn’t be surprising for a trader to ask themselves about whether CAD vol is cheap or expensive.  The CVOL reading of its own time series is likely preferred by FX traders who are consistently in the market. However, for investors that are looking to hedge flows or exposure they might not normally care to hedge, because of a historically tight relationship between CAD and USD, one can see these investors would not find CAD vol particularly onerous.

Drilling into the CVOL charts, I can further glean some information. Recall from the last section that when futures went higher, realized volatility also went higher. In the top chart here, one can see CVOL vs. futures prices. As a measure of implied volatility, or what traders expect going forward, there is less of a relationship between CVOL and futures prices. Does this present an opportunity? Perhaps.  And this may be what traders are latching onto, as demonstrated in the bottom chart. This chart shows the relationship between skew and futures price. Skew measures the relative pricing of upside CAD options vs. downside CAD options, or more simply, the expected behavior of implied volatility as futures move higher vs. move lower. On this front, I see a pretty clear pattern that the skew ebbs and flows with the movement of futures prices themselves. As futures fell to their lows in February 2025, there was higher demand for puts than calls, for downside options vs. upside options. As futures have moved higher, the relative demand has almost completely neutralized, and the skew moved back to zero.

Digging into the relative demand for puts and calls, I show two more charts. The top chart shows the implied volatility surface for all CAD options. A couple of things stand out. First, the term structure of implied volatility is in backwardation, with shorter dates having higher volatility than longer dates. Nervousness in futures price volatility is concentrated in shorter dated options even with tariffs pushed out for 90 days. Second, the skew is pretty flat across most parts of the term structure. Thus, if I were looking to do a skew trade, there isn’t a particular expiration I would favor. However, given the further I go, the lower the implied volatility, there may be a reason to look further out the curve than the shorter dated options expiring in the next couple of weeks.

The bottom chart zeroes in on a particular expiration, in this case the CD3K25 expiration, which is about a month away. Here I look at the volatility by strike to see the difference in implied volatility. At the tails on either side, I see that implied volatility is higher than ‌at-the-money, but puts are preferred. However, if I am nearer the at-the-money, plus or minus .01, I can see implied volatility is roughly the same.

Putting all of this together, I came away with the following takeaways:

1. There is no clear direction for CAD futures, as I can make the case for higher or lower CAD futures right now.
2. There is no clear direction for CAD volatility, as I can make the case for higher or lower CAD volatility from here.
3. There is a clear linkage between both realized volatility and the relative demand for upside vs. downside depending on the direction of futures prices.

This tells me that I don’t want to use options to take a directional view. I don’t even want to use options to take a volatility view. What should I do? This goes back to my FX roots 30 years ago. The best trade for this market is to trade the risk-reversal and hedge it. In particular, buying a CD3K25 .7375 call, selling a CD3K25 .7175 put and hedging it delta neutral.  This gets me long upside calls and short downside puts, and I hedge the position. There is no directional exposure (I am hedged at the start) and no volatility exposure at the start as both options have a similar delta. However, my exposure comes from what traders used to call “derive” or how my position changes as futures prices change. This is where I hope to make my money. Let me explain.

The bottom two charts show my exposure to vega and to gamma. The position gets longer both vega and gamma as the market moves higher, and short both vega and gamma as it moves lower. This should not be surprising as I’m long .7375 calls and short .7175 puts. As I move toward the call strike, it becomes more at-the-money so the Greeks get larger. Similarly, as I move away from the .7175, it is more out-of-the-money, so the Greeks get smaller.  The opposite is true as futures move lower and I move toward the short strike, the Greeks get larger (more negative). I see that the position will get longer vega and gamma as futures move up. Why is this a good thing? This is positive if there continues to be more demand for options as futures move higher, as seen in the skew metrics. Getting longer vega means as options demand moves higher, there is a good chance for me to trade out of my long options position.  Getting long gamma is also beneficial because I see realized volatility move higher with higher futures prices. Even if I am unable to trade out of my long options from a move in implied volatility, I should be able to more effectively delta-hedge my position in an environment with higher realized volatility. The risk is that realized volatility and/or implied volatility move higher as futures prices move lower. This is possible, and traders did see demand for downside options late in 2024. However, realized volatility is the earnings power of an options position, and realized volatility might be more likely to move lower with lower futures prices, so this is a risk I am more comfortable to bear.

Sometimes the markets are uncertain. I think it is fair to say markets are quite uncertain right now.  This does not mean there is no trade to do and no trade that can take advantage of this uncertainty. Using a hedge risk-reversal trade in CAD right now may be a good way to find opportunity in a market that can, and likely will, go either way going forward.

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