Another Forex Surprise? Blame Canada

A closer look at Canada's surprise rate cut and CBOE Volatility Index (VIX) options expiration

Jan 22, 2015 at 9:36 AM
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We can't have a day without news out of the blue. So for Wednesday I present -- Canada!

"The Bank of Canada shocked markets today by cutting its key overnight lending rate by a quarter of a percentage point, citing the economic threat posed by plunging oil prices.

"'The drop in oil prices is unambiguously negative for the Canadian economy,' Bank of Canada governor Stephen Poloz said in a morning news conference. 'Canada's income from oil exports will be reduced, and investment and employment in the energy sector are already being cut.'"

And as you would expect, the Canadian dollar tanked … over two months too late for my trip to Montreal, unfortunately (click chart to enlarge):

Canadian Dollar since Oct. 2014

But the market actually liked the news … at least, the stock market. Of course, Canada picked a bad day to make big news. We're all Europeans now.

"European stocks extended a seven-year high as the European Central Bank was said to plan further stimulus measures.

"The Stoxx Europe 600 Index rose 0.6 percent to 358.12 at the close of trading in London, reversing earlier losses after two euro-area central-bank officials said the ECB Executive Board has recommended asset purchases of 50 billion euros ($58 billion) a month until December 2016."

It's really all about timing. The market may have hit a better mood here, which makes the timing of the announcement pretty good. This story has gotten tons of publicity lately, so you have to think it's already discounted in the market. But maybe that won't matter. A market in a foul mood like we saw all of last week would have said Europe was indeed priced in. And then along comes Canada and … wham. We would have had 27 Canadian experts on telling us why the lower C-Buck is terrible for our economy somehow, and we should all sit up and notice.

Oh, and it was also CBOE Volatility Index (VIX) options expiration. That doesn't generally beget much in the way of market moves, but it can produce some interesting theatrics in S&P 500 Index (SPX) way out-of-the-money puts. And that can cause VIX to settle at a level much different from the actual VIX.

That wasn't the case, though. VIX settled at 20.97, very close to the opening "print" of 20.92. If you were short VIX into expiration, you got rather unlucky on the cash out. The ECB announcement and ensuing stock rally and volatility slam happened after the open. On the other hand, it's a zero-sum game in VIX paper -- so just as many benefitted. As is often the case, it highlights that the best advice is to simply close out or roll VIX paper and not expose yourself to the utter randomness of the VIX-piration process.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.



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