(Bloomberg) -- Pound traders who have grown used to Brexit brinkmanship between London and Brussels are making two assumptions: there’ll probably be a trade deal, and U.S. elections matter more right now.
It’s spurring demand for pound-bullish option bets and putting a kink in the currency’s volatility curve, which peaks at the one-month tenor. That’s well beyond the U.K.’s self-imposed Oct. 15 deadline to strike an accord with the EU, but just in time for the Nov. 3 vote in America.
Britain and the EU have been at a similar impasse in the past, only to reach some sort of compromise at the very last minute. With signs that officials are more upbeat -- at least in private -- when it comes to the prospect of clinching a deal, there’s little reason to believe that this time will be any different, the thinking goes.
Meanwhile, the possibility of a contested U.S. election is uncharted territory for markets, and deserves a higher risk premium given the stakes.
Deja Vu
In sign of the market’s positioning, sterling held its ground when the U.K. government warned Wednesday it would pull out of trade talks with the EU if there is no clear deal in sight next week.
Out of a notional 19.8 billion pounds ($25.6 billion) that traded through the Depository Trust & Clearing Corporation this month, 63% were pound calls, up from 44% in September. The CME Group (NASDAQ:CME) announced Wednesday that it executed the largest single options trade ever, a three-month pound call with strike at $1.40.
Risk reversals -- a gauge of market positioning and sentiment -- also show a familiar pattern unfolding when Brexit negotiations seemingly break down. Initially, demand for dollar upside exposure intensifies sharply when concerns grow, yet quickly retreats after the first round of hedging goes through.
Bets Are On
Over-the-counter trades paint a similar picture. There is large interest for so-called downside digitals in euro-pound and call spreads in cable, according to traders in Europe, who asked not to be identified because they are not authorized to speak publicly.
Investors are also going long volatility on structures that expire by end-October, early November, essentially betting that the pound may see large price swings around the U.S. presidential elections, the traders said.
Data Friday showed the U.K. economy grew at less than half the pace anticipated in August even as the government stepped up efforts to revive the beleaguered hospitality industry.
Given concerns about the pace of the recovery, and lingering global risks, options gauges show sentiment over the pound remains bearish overall in the medium term. But for now, the latest bets show a clear preference for the currency.
- 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