Sterling has been blasted lower after BoE governor Carney cast doubt on a previously pretty-much-expected UK May rate hike. The EU's rejection of Britain's latest Brexit-Irish border plan only served to deepen the rot.
Article / 23 June 2016 at 10:00 GMT

Saxo on Brexit: Volatilities market shows UK on a knife-edge

Today's the day, and the currency options market shows a very unsettled 
blend of sentiment as Britons go to the polls. Photo: iStock 

By Ben Ridgeway

On a damp day in London, close to 46.5 million Britons are expected to go to the polls in what is the third referendum in UK history. The first set of results are set to leak at approximately midnight (BST) tonight, with the final decision expected at around 0700 tomorrow. Should Britain vote to leave the European Union, Article 50 of the 2009 Lisbon Treaty is likely to be invoked, beginning the process of departure from the 28-nation bloc.

Latest polls indicate the sheer closeness of the debate. Of five survey companies that made publications yesterday, two – Opinium and TNS – showed a leaning towards a Leave vote. Three others, including ComRes for the Daily Mail and the respected YouGov for the Times, showed a higher percentage of those interviewed would vote to remain.

Bloomberg’s "number cruncher", a Bremain probability index, combines the polling average with analysis of the likely accuracy of those polls. The index assesses how public opinion changes in the run up to past referendums, notably those that concern the EU. Note how the Bremain likelihood took a tumble in mid-June, but has restored itself to reach approximately the 75% mark today.

BBG Grab
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Source: Bloomberg

The British pound currently hovers at around the 1.4800 mark versus the dollar, close its 2016 high achieved overnight in Asia of 1.4844. Depending on the outcome of the referendum, the December 25, 2015 high of 1.4948 or conversely the 200-day moving average of 1.4671 can be expected to be broken. 

Option volatilities are supported across the G10 space with sterling of course the main focus. Yesterday the interdealer currency options market saw the one-month straddle trade at a volatility of 22% and then, with spot much unchanged some time later, paid at 23.5%. This shows the propensity for movement in such a sensitive market. 

Traders are desperate to buy volatility and cover short positions. A downside move concerning spot cable in the event of Brexit could potentially be four or five times the size of an Bremain-influenced rise. This explains why the one month GBPUSD 25-delta risk reversal was paid at a volatility differential of 10.0%; downside protection is key. 

This is the highest level ever traded for this structure in cable. A key buying interest within the brokers yesterday saw a one month 1.5600 strike trade in close to one billion sterling, while a Friday 1.4100 strike printed at huge volatility of 100%.

Today, the overnight GBPUSD straddle begins with a mid. volatility of approx. 125.0%. Note how overnight at-the-money cable volatilities have multiplied by around 450% this week. A trader would thus pay approx. 870 USD-pips for an entry into this option, translating to a premium of $87,000 per one million sterling notional traded. 

The currency options trading desk in Copenhagen note that this is roughly 10 times higher than usual overnight volatilities in the run-up to a regularly occurring key event such as monthly US employment figures.

Within the EURUSD and EURGBP option markets, overnight volatilities trade at around the 45% levels. Note on the charts below how a gamma-related tenor such as one week in these currency pairs tend to move in tandem, including cable. 

The charts compare all three one-week straddles over the last three months. Upon the outcome of the referendum tomorrow, it may well be the direction of spot EURGBP that is more difficult to determine, with both currencies likely to either suffer of prosper, and a choppy nature likely to be evident in this particular space.

Source: Bloomberg

Source: Bloomberg

Sentiment in the retail market within Saxo Bank shows an undecided market with regards to sterling options; a real reflection on the closeness of today’s referendum. Note how USDJPY option show the strongest bias amongst all of the currency pairs below, as traders look to hedge long positions. The same can be said for XAUUSD. Spot buyers seek these safe-havens and conversely look to hedge this with option positions.

Retail FXO Positon Ratios
 Source: Trading

Whatever the outcome of the UK’s EU referendum, which will be known by this time tomorrow, the potential for volatility is high. This concerns not only the sterling space, but other G10 and worldwide major and emerging currencies too. 

The options market is driven on the petrol of volatility, and at the time of writing that volatility is largely moving lower. In the event of Bremain, a large-scale selloff may be evident. In the event of either outcome, there are opportunities aplenty.

Lastly a point to note aside from talk of currency option volatility. To quote Steen Jakobsen, Saxo Bank's chief economist, in a recent article entitled "Why the EU is the least of Britain's worries". I couldn’t agree more with Jakobsen regarding the below:
‘The most important question of all remains how we deal with the humanitarian crisis posed by the mass arrival refugees in a time of recession risk. How we act here will define both Europe and the UK in the future far more than whether the UK decides to leave."

The ongoing refugee crisis is as existential an issue for Europe as Britain's ballot. Photo: iStock 

— Edited by Michael McKenna

Ben Ridgeway is a sales trader with Saxo Capital Markets in London.


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