Photographer: Chris Ratcliffe/Bloomberg

Option Traders See Limited Pound Gains on Brexit Bill Deal News

  • Demand for outsized swings falls as worst outcome avoided
  • Implied volatility rises, yet stays below recent averages

Option traders got it right when they played down hype that next month’s European Union summit could be a one-stop shop for Brexit solutions. They are now betting the pound’s latest rally will be short-lived.

Even when U.K. Prime Minister Theresa May came under increased political pressure in early November, threatening the progress in Brexit negotiations, option gauges suggested that traders weren’t really worried the impasse would hold for long.

Demand for pound options anticipating relatively large price swings had risen this month, as shown by the so-called butterfly, but failed to surpass summer highs. As soon as news broke on Tuesday that the U.K. and the EU negotiators reached an outline deal on the Brexit divorce bill, out-of-the money options lost traction and the butterfly erased most of its November gains.

Even demand for at-the-money exposure failed to sustain its initial bullish momentum. One-month implied volatility dropped Wednesday by 15 basis points to 7.48 percent, almost 80 basis points below the year-to-date average.

The pound’s volatility skew suggests a more favorable path ahead for the currency, but one far from rosy. Risk reversals, a measure of market positioning and sentiment, remain firmly in favor of pound puts as Brexit looks to weigh on the U.K. economy’s prospects.

Even as options signal that sterling may see limited gains, technical analysis suggests the pound-dollar pair is trading at pivotal levels. The pair has met a potential “struggle” zone as macro bears step in to guard a downtrend line dating from 2014, which was at $1.3404 on Wednesday. Overcoming that resistance can see bulls make significant headway, with bears likely to revert to the sidelines until the next pressure point at $1.3800.

— With assistance by Sejul Gokal

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