Brexit Spurs Torrent of Options Trading in Last Hedging Rush

Why U.K. Staying in the EU May Prove an Equity Challenge
  • FTSE 100 is among Europe’s best performers, but puts jump
  • BOE Governor Mark Carney says EU exit could spark a recession

With only one month to go before the U.K. votes on whether to remain in the European Union, investors are piling into contracts protecting against stock swings, paying prices not seen in more than a year for the hedges.

More than 76,000 options on the FTSE 100 Index changed hands on average each day this month through the end of last week, the most in six years. That pushed a gauge tracking their prices up 3.9 percent, while another measure following euro-area contract prices fell. Traders are pricing in a 20 percent jump in U.K. equity volatility through June.

With Bank of England Governor Mark Carney saying this month that leaving the EU could lead to a U.K. recession, global fund managers have become even more wary of a market that was already their least favored. Their allocation to the nation’s equities has fallen to the lowest levels since 2008, according to a Bank of America Corp. survey published last week.

“Investors are extremely anxious about Brexit,” said Guy Foster, the head of research at Brewin Dolphin in London. His firm manages 32.8 billion pounds ($47.6 billion). “Nobody wants to own anything U.K.-facing going into the referendum.”

Even as polls suggest the campaign to remain in the EU is winning, the Bank of America report showed that investors consider the issue the biggest tail risk in the world. The pound, whose plunge this year has helped make the FTSE 100 one of the region’s best-performing gauges, is near the most undervalued it’s ever been, the note said.

“There are many people who, even if you told them the outcome of the vote, don’t know what the impact will be,” said Ben Kumar, an investment manager at Seven Investment Management in London. He helps manage $14 billion. “There is no consensus, and it’s very difficult to position most portfolios for that.”

A measure of FTSE 100 volatility expectations has jumped almost 40 percent since March, while actual market swings have dropped, data compiled by Bloomberg show. Eight of the 10 most-owned options on the index are bearish. The FTSE 100 was little changed on Monday at 9:08 a.m. in London.

BOE officials have said the weakening economy may not be due only to Brexit concerns. A report last week revealed signs of cooling in the labor market, with job creation in the first quarter running at a fraction of the pace seen at the end of 2015. Credit Suisse Group AG said the following day that investment and employment decisions being postponed until after the June 23 vote partly explain the slowdown. Morgan Stanley warned that U.K. and European equities could fall as much as 20 percent in the event of Britain exiting the union.

“Insurance in the U.K. stock market is so high because the financial implications and capital loss due to Brexit could be quite high,” said Patrick Spencer, equities vice chairman at Robert W. Baird & Co. in London. His firm manages $151 billion. “If you are a physical holder of equities, your biggest concern is going to be a meltdown in the U.K. market. This is unknown territory, and markets hate uncertainty.”

Michael Bloomberg, the founder and majority owner of Bloomberg LP, the parent company of Bloomberg News, has publicly supported the campaign to keep the U.K. in the EU.

 

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