Pound traders betting the U.K. and European Union are bluffing in their latest Brexit dispute are set for a windfall if history repeats itself.
That’s because options to position for sterling gains have now become relatively cheap, as most investors are rushing the other way to hedge against a slump in case Britain fails to agree a trade deal with the bloc this year.
Those betting on a 5% pound advance over the next six months pay 30% less than for an equivalent wager on a drop, according to Bloomberg calculations on options pricing. Contrarian trades that bank on the U.K. and EU ironing out their latest dispute made up a third of the total in the options market in the past week.
“For investors willing to look through some near-term volatility, current levels for sterling longs now look attractive,” Goldman Sachs Group Inc. strategists including Zach Pandl wrote in a note. The odds of a “no deal” should be lower than the market is implying, they said.
And such a view has precedent on its side, given the U.K. and EU have come to the brink before, but ended up pushing back deadlines and reaching deals. This time a trade agreement is needed next month to avert a chaotic exit when the U.K.’s transition period finishes at the end of December.
The pound is holding its ground for now near $1.29, after slumping more than 5% in 10 days earlier this month, even as the U.K. Parliament passed an initial reading of a bill that could override the Brexit divorce accord. The EU has given the government until the end of the month to scrap that planned law or face legal action.
The risks means many currency investors have been piling up bearish pound bets in an almost unprecedented fashion. Options over six months, which capture the end of the transition period and any subsequent market turmoil, saw the second-biggest move on record last week toward negative sentiment for the pound.
And as investors drive up puts looking for a large fall, the currency’s volatility chart across probabilities looks more like a smirk. Should a Brexit breakthrough materialize, the curve will shift to resemble a smile, as calls rally. Certainly pound bulls would be happy.
- NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice