|12 December, 2019

Sterling derivative markets flash red as British election gets underway

Traders rushed to the foreign exchange derivative markets on Thursday to protect their exposure to the British pound

LONDON- Traders rushed to the foreign exchange derivative markets on Thursday to protect their exposure to the British pound in case of a surprise election outcome.

The premium for pound puts over calls over the next week jumped to its highest since September 2016 at nearly 6%. That means more investors want downside protection from buying the right to sell the pound over the next week. 

While the cash markets were relatively quiet, overnight implied volatility gauges jumped to 45%, their highest since around the Brexit referendum vote in June 2016 as investors braced for a rocky night.

A closely watched model from pollsters YouGov earlier this week put Prime Minister Boris Johnson on course to win a majority of 28 in parliament on Thursday, down from a forecast of 68 last month. YouGov also said its model could not rule out a hung parliament, where no party gains a majority. 

While financial markets are positioned for a Conservative Party majority, investors have ramped up hedging their British exposure in the case of a hung Parliament.

Adam Cole, chief currency strategist at RBC Capital Markets, said price action for the pound during the campaign suggested the currency should have a fairly linear and positive relationship with the expected Conservative majority and would gap much lower on an expectation of a hung parliament.

Voters headed to the polls on Thursday in an election that will pave the way for Brexit under Prime Minister Boris Johnson or propel Britain towards another referendum that could ultimately reverse the decision to leave the European Union. 

Investors in the cash market have bet on a Conservative Party majority.

In early trading on Thursday, the pound was steady around $1.3196 against the dollar and 84.30 pence versus the euro.

(Reporting by Saikat Chatterjee; Editing by Tommy Reggiori Wilkes, Larry King) ((saikat.chatterjee@thomsonreuters.com; +44-20-7542-1713; Reuters Messaging: saikat.chatterjee.reuters.com@reuters.net))

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