- Traders are protecting against at drop in the pound they expect in the next week.
- More traders are also betting that there will be less upside in the pound versus the US dollar.
- Britain votes in an election on Thursday. The pound has rallied as polls indicate a decisive Conservative victory.
- “The share of undecided voters at this stage does not rule out the risks of sizable electoral surprises that could lead to a hung parliament,” which is a risk to the pound’s price, Goldman Sachs said.
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- Watch the pound trade live here.
Traders are piling into bets that suggest they see downside risks to the pound from a probable Conservative win in a UK election later this week.
If Prime Minister Boris Johnson gets a decisive win, he will pull Britain out of the European Union — a likely negative for the pound.
Potential shocks from election day on Thursday are driving up demand, and thus the price, of bearish derivatives. Options traders are protecting against a drop they expect in the next week — and the volume of those downside bets is outweighing that of the upside ones to a degree not seen in a few years, Goldman Sachs strategists said in a note dated December 9.
“The share of undecided voters at this stage does not rule out the risks of sizable electoral surprises that could lead to a hung parliament,” the report said.
Volatility levels are also near October highs, “when uncertainty on the new Brexit deal was elevated.”
The chart below measures this volatility spread, called one-week 25-delta risk reversal, at near a July 2017 high. It’s a sign traders want to hedge their positions should UK voters deliver a loss for the Conservatives or another unexpected outcome on election day, Goldman said.
The pound soared on the news this week that Britain’s Conservatives were holding an 8 to 16% lead over the Labour Party in the polls, a sign of a decisive Tory win.
But a relatively modest swing in the other direction would trigger a hung parliament, where no party has enough seats to claim an overall majority.
The uncertain outcome is making traders pile into the positions.
Investors are also betting recent gains in the pound are close to capping. Goldman Sachs said implied volatility “is pricing less upside risk of a further GBP/USD rally,” as shown in the chart below (“GBP/USD 1-month implied volatility based on different deltas”):
“GBP/USD implied volatility is already pricing higher uncertainty towards next December, another important Brexit deadline,” Goldman Sachs said.
A win for Labour wouldn’t necessarily mean doom for the pound, however. If the Conservatives win, Goldman currency strategists see the pound reaching $1.35, “while in case of a Labour victory, the result could be more mixed as higher Brexit uncertainty near-term may in part be offset by the potential for a softer Brexit end-state.”
“A hung parliament would prolong the uncertainty,” and the pound could drift to $1.25.
The pound was at about $1.32 in afternoon trading in London on Tuesday.
Longer term, the bank’s strategists “maintain a constructive view on UK assets due to light investor positioning,” Goldman strategists including Alessio Rizzi wrote in the note. “We continue to prefer UK domestic exposed stocks given the attractive valuations and the high sensitivity to UK growth.”
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“In rates, Gilts, which have recently moved in line with US and German bonds so far, are likely to underperform,” they wrote. “Continued high political uncertainty represents a downside risk to this view. “
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