By Tom Finn and Ritvik Carvalho
LONDON (Reuters) – Traders dealing the British pound have been on a wild ride this year thanks to Brexit headlines. The latest instability in Westminster has meant price swings in the pound are bigger than those in the euro by margins not seen since Britain’s EU membership referendum in June 2016.
Implied volatility gauges – or expected swings in the price of the British pound – surged this week, yanking the gap between one-month measures of sterling and euro volatility to two-year highs.
Graphic: Sterling and euro volatility spread widest since run to Brexit vote – https://tmsnrt.rs/2SEnMkL
The pound fell to a 20-month low at $1.25 on Tuesday after a media report that lawmakers had enough letters to trigger a no-confidence vote in Prime Minister Theresa May’s leadership.
That constituted a drop of more than one percent from the day’s high – a massive move for a major currency. But on Monday, the pound’s intraday trading range was 2 percent – levels more commonly associated with the likes of the Turkish lira <TRY=> and the Indian rupee <INR=>.
“Volatility, creeping up slowly over the course of the year, has now shot right up,” said Ulrich Leuchtmannan, an FX strategist at Commerzbank.
“For some investors it is strange but… you really have to treat this currency with a lot of caution now. Sterling volatility has woken up from its 100-year slumber.”
Sterling’s three-month implied volatility stands at 15 percent, its highest since June 2016. By comparison, three-month implied volatility in the Turkish lira <TRY3MO=>, one of the most volatile emerging market currencies, is at 20 percent.
Graphic: Narrowing gap between 3-month implied volatility between sterling and Turkish lira – https://tmsnrt.rs/2PvKytm
Fuelling the spike in volatility in the pound is the myriad possibilities that the postponement of the British parliament’s vote on May’s Brexit deal with the European Union has thrown up for investors.
A raft of possible outcomes include a disorderly no-deal exit of Britain from the EU, another referendum on EU membership and a last-minute renegotiation of May’s deal with Brussels.
Prolonged uncertainty has prompted investors to take to currency derivatives markets to execute their views.
Any sign of a Brexit deal could trigger a sharp pullback in implied pound volatility, reaping profits for traders who had sold structured products.
Graphic: Sterling implied volatility higher than several EM currencies – https://tmsnrt.rs/2SGl5iKSome of these structured products allow traders at large banks to sell option structures that allow them to collect large premiums when volatility is elevated, but also offers them the upside of making big profits if certainty about the Brexit outcome finally materialises.
“Large quantities of these so-called put spreads have been sold so any drop in volatility levels could trigger windfall gains to the option writers,” one trader at a large bank said.
(Reporting by Tom Finn and Ritvik Carvalho; Writing by Saikat Chatterjee; Editing by Mark Heinrich)