How to Trade the Canadian Dollar

NEW YORK ( TheStreet) -- The December Canadian dollar futures contract is trading a tad lower this morning at 1.0153, down 10 ticks.

The contract has seen large gains over the past four months, moving from a low in June of 0.9568 to a high reached mid-September at 1.0380, as hopes for additional stimulus along with some better-than-expected economic data drove equities and commodities higher.

As the Fed has now come out with its "unlimited" bond-buying program, it is clear that the intent is to continue to keep risk appetite high as investors are forced to chase yield. This, in turn, should logically keep commodities and other assets inflated for the foreseeable future.

Natural gas has been on the rise with colder-than-average weather on the horizon, crude oil bounced off the $90 per barrel floor like a rock, and although down as of this writing, gold may be poised for a monumental move to the upside if resistance is taken out at 1,790-1,800.

These factors all bode well for the Canadian Dollar. The only potential negative that I see is it appears to me that the equity bulls are looking a little bit tired here. What I am thinking, therefore, is that we see a little bit of consolidation and range-bound trade in several markets, the Loonie included.

In addition, the contract on the daily chart is trading below the 20-day moving average but above the 50-day moving average. The 50 is at approximately the 101 area while the 20 is in the 102 area. I feel there is a decent likelihood that price spends a little time in between "consolidating." After all, the overall trend is higher, and therefore I would expect the 50-day moving average to hold on the downside.

Looking at Canadian dollar options, the options are currently trading at an implied volatility of 7.9% versus a statistical volatility of 7.1%. Current 60-day implied volatility levels are in the 99th percentile. This information tells me that these options may be overpriced and thus offer a trading opportunity with some edge.

Because, in my opinion, the options are overpriced, I feel an option-selling strategy might be suitable. Depending on one's outlook and risk tolerance, either straddles or strangles may be used. In this case, I prefer the straddle. Looking at the November options, time decay should work quickly in the trade's favor as the November options have only 39 days until expiration. That, along with a potential drop in implied volatility can give this trade some edge.

Keep in mind that these are sophisticated option strategies with unlimited risk and are therefore not suitable for all investors. An investor can lose more than his original investment. Here is one way to potentially take advantage of some over-inflated option premium. Keep in mind this is just one way to try to accomplish this. Feel free to email me if you are interested in discussing additional or limited risk ways to take advantage of overpriced options. Please note today is Oct. 2 and trade data is based on the most recent data:

Sell the November Canadian dollar 101 straddle for 190 or better ($1,900 before commissions and fees).

Risk on trade: unlimited.

Target: Look to buy this straddle back for 90 or lower.

Profit potential: Limited to the premium collected minus commissions and fees. In the scenario above, profit would be $910 after subtracting a R/T commission of $45 inclusive of all fees per contract.

Break-even points: This trade breaks even at expiration at 1.0282 on the top and 0.9829 on the bottom. If the position is held until expiration, and the market is outside of that range, a loss of $10 per point above the top breakeven or below the bottom breakeven will be incurred.

Please note: Futures and options trading is inherently risky and isn't suitable for all investors. Past performance isn't indicative of future results. Stop-loss orders meant to limit losses may not be effective because market conditions may make it impossible to execute such orders.
Matt Zeman is a trader at Kingsview Financial. He began his trading career as a runner in the grain pits at the Chicago Board of Trade before becoming an arbitrage clerk. Eventually he started trading equity options and stocks. Matt now is a full-time futures broker. He has been a frequent guest on CNBC, Fox and Bloomberg, and provides his views on the stock, bond and futures markets for financial media including Dow Jones, the L.A. Times and The Associated Press. Matt is a member of the Chicago Board of Trade, and carries series 3, 7 and 66 licenses.