Investors are taking to option markets to bet that the pound will keep tumbling, with some strategists saying there’s a growing risk of the currency hitting parity versus the greenback for the first time ever.
(Bloomberg) —
Investors are taking to option markets to bet that the pound will keep tumbling, with some strategists saying there’s a growing risk of the currency hitting parity versus the greenback for the first time ever.
Henry Drysdale, head of currency options trading at Natwest Markets, is telling clients to position for more weakness in the pound as volatility picks up. And while dollar-sterling parity — narrowly averted in 1985 — is not Natwest’s central case, they recommend nonetheless that clients seek protection against that scenario in options markets.
“We think the market hasn’t yet sufficiently priced in a premium for the increased uncertainty for the months ahead,” Drysdale wrote.
Battered by a combo of messy politics, high inflation and looming economic recession, the currency had enjoyed a brief respite in recent days as the dollar retreated. But on Tuesday, it resumed its slide to approach $1.14, its weakest since 1985, after hot US inflation data boosted the dollar and revived wagers on an aggressive Federal Reserve.
Investors have steadily dumped the pound this year — while losses have been most pronounced against the dollar, it has also fallen around 3% versus the euro. Aside from stubbornly high inflation and recession risks, Britain has a record current account deficit of more than 8% of GDP, a gap that may blow out further as the government prepares to spend on capping households’ energy prices.
Options markets imply “a more than 25% chance of the GBP/USD exchange rate hitting parity over the course of next 12 months,” Drysdale added. That is more pessimistic than Bloomberg’s forecast, based on volatility calculations and economist estimates, which sees a 19% chance the pound will hit parity in a year’s time.
Tim Brooks, head of options trading at market-maker Optiver, noted high demand among investors for options that allow them to sell the pound if it hits $1.05 over the next six months. There is also early-stage interest in protecting against a fall to parity and little demand to hedge against any potential pound upside, he said.
According to Brooks, after a significant move lower in a currency, options tend to price the possibility of a rebound but this was not evident in the pound’s case.
For instance after a sharp euro-dollar fall “you will see front-end risk reversals actually move to euro calls as market participants bet on a sharp reversion,” he said. A call option allows the holder to buy the asset.
But “there’s much smaller interest in pound upside,” he added. “It shows that the market views further downside in pound as a legitimate possibility.”
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