Bets on a Strong Pound Are Getting in the Way of a Strong Pound

(Bloomberg) --

Investor optimism on the pound hasn’t been this high for quite some time, yet that may have landed the currency in something of a Catch-22.

Unlikely as it sounds, one reason why sterling is struggling to extend October’s sizzling run is probably an overwhelmingly bullish option-market bias.

For one, traders already positioned for a stronger U.K. currency via derivatives may wait to get past the uncertainty around the Dec. 12 election before adding to allocations. Also, investors long on options tend to sell the currency in the spot market every time it rallies, in order to protect the value of their contracts -- a practice known as delta hedging.

Option bets for a stronger pound have climbed to levels unseen earlier this year after Prime Minister Boris Johnson’s success last month in securing a Brexit deal and winning preliminary approval from lawmakers. Demand for vanilla sterling calls now outweighs that for puts by 50% since October, after remaining almost perfectly balanced on average through the first nine months of the year, data from the Depository Trust & Clearing Corporation show.

The median forecast of strategists for sterling’s year-end level has jumped almost 6% from October’s lows to $1.29, according to Bloomberg surveys. The currency was around $1.2940 Thursday, little changed in November after last month’s 5.3% gain that was the biggest since 2009.

To be sure, the pound’s listlessness also has a more straightforward reason -- the currency has already had a stellar rally of more than 8% from September’s three-year low, and that means most short-term traders are probably satisfied with returns for now.

While the fear of a no-deal Brexit has faded, some analysts remain concerned that a floundering U.K. economy and the prospect of fraught trade talks with the European Union could rein in the pound. The risks surrounding next month’s vote -- particularly the prospect of a hung parliament or a coalition led by the Labour Party -- are also seen as headwinds for the currency.

Still, most potential election outcomes point to a stronger sterling -- Bank of America Merrill Lynch sees a rally of almost 8% in 2020 on the prospect of a win for the ruling Conservative Party that would put an end to the Brexit deadlock. However, for any significant gains to materialize, some of the outstanding options need to expire or be rolled over to make room for fresh momentum to emerge. Thursday alone, 3.38 billion pounds ($4.4 billion) are due to expire at strike prices ranging from $1.2945 to $1.3000.

• 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

To contact the reporter on this story: Vassilis Karamanis in Athens at vkaramanis1@bloomberg.net

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Anil Varma, Neil Chatterjee

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