Investors Scramble for Pound Hedges as Brexit Drama Flares Up

(Bloomberg) -- As U.K. Prime Minister Boris Johnson hardens his no-deal rhetoric and fuels mounting anger in Parliament, the hunt is back on for hedges to protect against the worst-case scenarios for Brexit.

The dash is showing up in currency market derivatives, with one investor betting a notional 190 million pounds ($235 million) that sterling will fall more than 10% to $1.108 by the Halloween deadline for leaving the European Union. Options remain the most efficient pound bets amid the possibility of a chaotic divorce and a left-wing Labour government, according to Allianz Global Investors.

Sterling steadied on Thursday after Johnson came out fighting in the House of Commons, refusing to resign or apologize after the U.K. Supreme Court ruled unanimously that his decision to suspend Parliament had been unlawful. The pound has gained more than 2% since early September yet persistent uncertainty around when and how Brexit will take place is helping to keep fund managers on the sidelines.

“If you are expecting a big move, then deep out-of-the-money options will provide the best possible payoff,” said Kacper Brzezniak, a portfolio manager at Allianz. “The Brexit issue has not been solved and no deal, Corbyn or no deal with Corbyn, are all still very much possible,” he added, referring to Labour leader Jeremy Corbyn.

NOTE: Pound Confronts Brexit Reality as Exuberance Fades

For Allianz, a “staggering” number of unlikely events need to happen before a Brexit deal can be secured, and that means a directional bet on the currency remains too risky.

In contrast, options remain “not too expensive” with implied volatility falling from recent highs, Brzezniak said. The out-of-the-money put option is a bet that the currency will slip from current prices over a set period of time. Out of a notional total of 78.6 billion pounds worth of pound-dollar options since Sept. 1, 40 billion pounds were on bets looking for a weaker pound as of Wednesday. One third of these were on strikes $1.20 and below.

Currency options aren’t the only way investors are hedging their risk. Bets are being racked up in the money market for a disruptive Brexit that will force the Bank of England into aggressive monetary easing.

--With assistance from Vassilis Karamanis and Neil Chatterjee.

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net, William Shaw, Michael Hunter

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