- Contracts hedging a drop to $1.35 more than double since March
- Protection costs rise to records as Brexit camp pulls ahead
The amount wagered on the pound falling to 1980s levels has more than doubled during the past three months.
With barely a week until Britons vote on membership of the European Union, polls increasingly suggest an exit is a real possibility. Investors are responding by bolstering their protection against sterling declines, and have bet 25 billion pounds ($35 billion) this year on options that would profit if the currency tumbled to $1.35 or lower after the June 23 vote.
That’s a more than 4 percent drop from current levels and would see the pound weaker than its 2009 low of $1.3503 to revisit rates last seen in September 1985. The recent clamor for hedges, particularly when the costs of protection have surged to record highs, shows how investors are suddenly less dismissive about the prospect of the U.K. quitting the world’s largest single market.
“The market for sterling and sterling protection is being led by the nose by the opinion polls,” said Alvin T. Tan, a London-based foreign-exchange strategist at Societe Generale SA, which at the end of 2015 warned about the risks of the EU vote when the bulk of the market was predicting a stronger pound. “About two weeks ago, the market was still quite complacent.”
Tan still doesn’t expect a Brexit to happen, and sees the pound ending the year little changed at $1.42, from about $1.4160 on Wednesday in London. If Britain opts to quit, he predicted a decline to $1.30 within two weeks of the vote and a longer-term slide to $1.20. Hedging pound losses has become too expensive, he said, and recommends selling the euro against the dollar on the assumption that Brexit contagion would spread.
The amount at stake in bearish sterling options is about equal to the size of the economies of Jordan or Bahrain and more than half the gross domestic product of Luxembourg.
Of the 25 billion pounds wagered through options in 2016, 3.6 billion pounds was placed this month as surveys started to show consistent multi-point leads for the campaign to get Britain out of the EU. The total value of the contracts is up from 11 billion pounds in late March, about a month after the referendum was announced, data from the Depository Trust & Clearing Corp. show.
“It’s got more expensive, but people are still hedging,” said Neil Jones, London-based head of hedge-fund sales at Mizuho Bank Ltd., who predicted a year-end drop to $1.35, or $1.25 on a Brexit vote. “One can’t afford to run the risk.”
The pound fell to a two-month low Tuesday after a TNS U.K. Ltd. survey showed a seven percentage-point lead for those wanting out of Europe -- the latest in a run of five polls backing a Brexit.
Sterling is down about 4 percent versus the dollar this year -- the sole Group-of-10 currency to fall -- after briefly wiping out its 2016 decline last month as polls suggested the “Remain” camp was gaining ground. Median estimates in Bloomberg surveys are for year-end gains to $1.48 and 74 pence per euro, from about 79 on Wednesday.
The premium for one-month options to sell the pound versus the dollar compared with those to buy widened to an all-time high of 9 percentage points Tuesday, up from less than one percentage point in late May, risk-reversals data compiled by Bloomberg show.
Net costs of hedging sterling losses over two weeks and three months also reached record highs on Tuesday.
Options prices compiled by Bloomberg imply a 35 percent chance sterling will fall to $1.35 by the day after the vote and a 25 percent probability of it rallying to $1.50 -- a level last seen in December.
“Investors are struggling with binary risk,” said Ugo Lancioni, a currency money manager in London at Neuberger Berman Group LLC, which oversees $243 billion. “The demand for sterling protection has continued to be strong. It’s challenging to deal with in/out, yes/no scenarios, and the options market is telling us something about the level of uncertainty.”