Pound's $16 Billion of Option Trades Envisage Drop to 1980s Lows

Boris Swims Against Tide of ‘Brexit’ Warnings
  • Bets placed on drop roughly equal to size of Iceland's economy
  • Three-month volatility options now span the referendum day

As Britain ponders its future in the European Union, investors are betting an amount almost the size of Iceland’s economy on the pound falling to levels last seen in the 1980s.

At least 11 billion pounds ($16 billion) has been wagered this year on options that would profit if sterling fell to or below $1.3502, a 4.5 percent drop from current levels, after the June 23 referendum. More than half of the positions were placed since the date of the vote was set on Feb. 20.

The figures give an indication of what’s at stake as investors weigh the possibility of the U.K. quitting the world’s largest single market, which accounts for about half its imports and exports. Even with opinion polls showing no clear lead for either side, the prospect of a “Brexit” has seen the pound fall more than any other major currency versus the dollar this year.

“There is a risk premium in sterling, both in terms of the spot rate and in terms of the volatility market, but this is one of those events where you have no way of calibrating how big it should be,” said Paul Meggyesi, a foreign-exchange strategist at JPMorgan Chase & Co. in London. “Few investors believe that sterling has fallen to levels where the risk-reward favors buying.”

1985 Lows

While tumbling to $1.3502 would barely exceed the pound’s decline so far this year, it would take the U.K. currency to the lowest level since 1985. Traders assign 54 percent odds to sterling reaching that level by the day of the referendum, according to Bloomberg’s options calculator.

Meggyesi sees the pound falling to $1.38 by mid-year, from $1.4145 as of 4:45 p.m. London time on Thursday.

Even forecasts of a drop to these levels may be optimistic if the U.K. actually ends up leaving the EU.

If a vote to leave resulted in a “messy” divorce from Europe, then the U.K. economy would likely fall into a recession and the pound would drop to about $1.15 by the end of the year, Nick Kounis, ABN Amro Bank NV’s Amsterdam-based head of macro research, wrote in a note.

In December, the Dutch lender predicted sterling’s recent levels more accurately than any other lender. The median estimate in a Bloomberg survey of analysts puts sterling little changed by the end of the second quarter.

Post-Announcement

Investors have stepped up weaker-pound wagers in the past month. Of the 11 billion pounds outstanding, 6.5 billion pounds were placed since the referendum data was set on Feb. 20, data from the Depository Trust & Clearing Corp. show.

And sterling’s likely to have a rough ride on the way to these declines. Implied volatility spanning the June vote jumped to an almost six-year high of 15 percent, suggesting traders are more concerned about price swings than in the run-up to the 2015 elections or the 2014 Scottish independence referendum.

“On an actual Brexit result we will revisit some of the highs not seen since the financial crisis on volatility -- we can get into the 20s,” said Neil Jones, head of hedge-fund sales at Mizuho Bank Ltd. in London. The pound may fall to as low as $1.20 on a vote to leave, he said.

Mayoral View

For many, there’s nothing to fear from quitting Europe. London Mayor Boris Johnson told lawmakers on Wednesday that the capital’s finance industry would “flourish mightily” if Britain left, and said support for staying in is “shallow” among business leaders.

An ITV Plc/ComRes opinion poll conducted March 18-20 showed 48 percent of respondents backed remaining in the EU, with 41 percent saying they’d vote to leave. An ICM survey on the same days showed 43 percent support for quitting and 41 percent wanting to remain.

Currency traders aren’t taking the chance that everything will be fine after a potential U.K. exit.

The premium on options to sell sterling compared with those to buy more than doubled to a record on Wednesday once the measure encompassed the day of the referendum. It jumped to 4.3 percentage points, also spurred by the Brussels terror attacks, which were seen boosting the case of anti-EU campaigners concerned migration is too high.

“We used the recent appreciation in the pound against the dollar to add to our short-sterling position,” said Mark Dowding, a London-based money manager at BlueBay Asset Management LLP, which oversees $60 billion. He added that sterling should be trading in the high-$1.30s. “Here and now, the probability of a leave vote is somewhat under-priced.”