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Bears Ditch U.K. Stock Hedges With Brexit Taking Back Seat

  • The FTSE 100 is outpacing the Euro Stoxx 50 this year again
  • Investors are focusing on hedging for France, German turmoil

As stock hedging goes, Brexit isn’t the uppermost on investors’ minds these days.

With traders preparing for political risks in the continent, the cost of protecting against FTSE 100 Index declines has fallen to near its lowest level since April relative to protection prices for the Euro Stoxx 50 Index. At the same time, the ratio of bearish to bullish options outstanding on the U.K. gauge hasn’t been this low in seven months, while it’s climbed to its highest since 2002 on the European measure.

“Between the elections in Germany and France and an increased political risk, we are facing quite a bit of uncertainty in Europe,” said Daniel Murray, head of research at EFG Asset Management in London. “Investors don’t like uncertainty, hence there is some hedging on the downside. The story of British stocks looks brighter, a lot of Brexit-related concerns have been priced in, and there is more clarity as to what we are to expect.”

The turmoil that followed last year’s Brexit referendum is easing, with the Bank of England raising its growth projections for the second time since then. A dramatic weakening in the pound boosted the exporter-heavy FTSE 100, while gauges of small- and mid-cap shares also reached records as the nation’s economy weathered the vote’s aftermath. The FTSE 100 headed for its biggest gain in seven weeks on Friday.

On the other hand, the two biggest nations in the euro area are going through turbulent election campaigns. Francois Fillon’s presidential bid in France is imploding, raising concern National Front candidate Marine Le Pen may win the May ballot, while German Chancellor Angela Merkel’s lead ahead of the September vote slipped. The Dutch will head to the polls in March, and Italy may also call for an election.

Here are some figures on the U.K. options market:

  • The put-to-call ratio on the FTSE 100 has dropped 20 percent from a high in September as the index rallied, becoming one of the region’s best performers in 2016.
  • Conversely, the ratio on the Euro Stoxx 50 has climbed 12 percent since September.
  • While protection is cheap for both indexes, the cost of hedging against a 10 percent drop in the FTSE 100 relative to bets for gains of the same magnitude is about 12 percent lower than for wagers on the Euro Stoxx 50.
  • The price relationship known as skew is also near its lowest level since August 2015 for the U.K. gauge relative to the S&P 500 Index.

One word of caution: Most of the bullishness in the FTSE 100 came thanks to the weaker pound, which prompted analysts to raise their earnings-growth estimates for companies on the gauge. A continuation of the rebound in the currency started mid-January could spell trouble for the measure, according to Pierre Martin, a trader at Saxo Bank A/S in London.

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