Capstone’s Britton Says Market Still Not Pricing In Brexit Odds

  • Derivatives on pound and U.K. stocks still cheap, manager says
  • Market offering ‘fantastic risk-reward trade’ on possible exit

Paul Britton, founder of the $3 billion Capstone Investment Advisors, said markets in the U.K. are failing to keep up with polling data signaling growing support for the nation to exit the European Union.

While the “Remain” camp held the lead for much of May, recent surveys show the race may be narrowing as the June 23 vote approaches. The pound and benchmark stock index dropped this week after ICM polls released by the Guardian showed “Leave” taking a lead.

Despite the selloff, derivatives used to bet on the volatility of those markets are still cheap relative to the probability of a so-called Brexit, Britton said in a telephone interview. His New York-based hedge fund firm, which uses volatility-based strategies to trade securities, bought put options on the pound and FTSE 100 Index with the expectation that market fluctuations will increase over the next month, he said.

“It’s a fantastic risk-reward trade,” said Britton, 42, who grew up in the London suburbs. “If for whatever reason there is an exit then the market is going to be caught so badly offside. It’s just not pricing in that probability at all right now.”

Implied one-month volatility closed at 20.5 percent Thursday after spiking in the past week. At a bid of 19.5, the payout for the options if the pound falls to $1.35 is about 5 to 1, according to Britton. Options are derivatives that give the right but not the obligation to buy or sell an underlying security at a set price and date.

Tail Risk

The pound -- which traded at $1.44 as of 5 p.m. Thursday in New York -- may fall to as low as $1.25 if the U.K. opts to leave, or rally to $1.50 if the nation remains, Capstone estimates. The company began wagering on price swings around the referendum two to three months ago, said Britton. He said he hasn’t donated to either of the referendum campaigns and declined to comment on which way he’ll vote.

A Bank of America Corp. survey published last month showed that fund managers consider the issue the biggest tail risk in the world. German Chancellor Angela Merkel warned Thursday that the U.K. would be isolated and lose influence if it leaves the 28-nation bloc. Campaigners for leaving argue that the U.K. can continue doing business freely with the EU and reach favorable free-trade deals with the rest of the world once out of the bloc.

Since the date of the vote was set on Feb. 20, at least 17.6 billion pounds ($25.4 billion) have been wagered on options that would profit if sterling fell to or below $1.35 after the referendum. Still, as of late Thursday traders assigned only about a 13 percent chance of the pound reaching that level once the referendum results are known, according to Bloomberg’s options calculator.

Capstone was founded in 2004 and initially managed internal capital and separate accounts. Britton’s flagship Capstone Vol fund, started it 2007, uses options to bet on fluctuations in prices across equity, bond, currency and commodity markets.

The fund, one of the largest of its kind, returned 2.5 percent this year through May 27, according to a person with knowledge of the matter. The SG Volatility Trading Index, which tracks the performance of volatility-trading hedge funds, rose 3.5 percent through April, the most recent data available.

Michael Bloomberg, 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 union.

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