We are concerned about the fact that it is generally expected that the BoE would cut its key rate (possibly as early as tomorrow). This rate cut may be sufficiently priced in on the FX hedging market to ensure that it wouldn’t lead to any further damage to FX portfolio by additional Sterling weakness.

BoE governor Mark Carney was very dovish in his recent speech stating that ‘some monetary policy easing will likely be required over the summer’ due to a deterioration of the economic outlook.

There are initial signs that growth is slowing further after Brexit as both business confidence and consumer confidence have fallen markedly and the number of job vacancies has decreased by 700,000. We do not buy into the story that the BoE will have to tighten monetary policy, as a weaker GBP would lead to higher inflation. So let’s not be more hawkish to expect aggressive cuts.

With resultant effects, the GBPAUD cross is anticipated to depreciate further, most likely towards 1.83 levels.

Since OTC markets seem to be highly volatile with short term bullish underlying performance, and IVs are expected to fade away (at around 13.76%) for 1M tenors. This would be the good news for short-term put option writers contemplating the prevailing bearish environment but more numbers of longs in ATM delta puts would ensure the reasonable probabilities in underlying exposures considering the major bearish trend.

To factor in the weakness in this pair as we could see reasonable IVs even  in next 1-3m expiries, we recommend capitalizing more on bearish signals and the IV factor in the long term by employing OTM longs matching with ATM longs to construct back spreads that likely to fetch positive cash flows.

Please be certain that a large downward move in the underlying spot should be allocated with longer tenor and can be withstood without losing any money.

So, to set up this strategy, initiate longs in 2 lots 1M ATM -0.50 delta puts, long in 2M (1%) OTM -0.36 delta put, and simultaneously short 2W (1.5%) ITM shorts, the spread is to be executed in the ratio of 2:1 at net debit.

The higher delta of the strategy would mean that there is more likelihood of expiring ITM, since the major downtrend seems more robust we preferred 1 lot of extra-long of slightly OTM strikes in our Put Ratio Back Spread.