As the outcome of the UK 23rd June referendum remains uncertain but the fears of Brexit sword lingering around GBP crosses – so there is value in conditional trades expressing Bremain or Brexit scenarios.

If the UK voters decide to remain in the EU, the GBP front end and belly will reprice higher for sure as the market scales down BoE rate cut fears.

Looking at how the segmented forward curve has performed since the start of 2016 (see 1st graph), it is clear that it is the 4-5Y area of the curve that remains the most vulnerable.  

Buy GBP 3m5y payer spread ATMF+5bp/ATMF+35bp, sell EUR 3m3y2y mid-curve payer ATMF FX- and PV01-weighted, zero cost (indicative). The strategy has a maximum profit of 30bp in 3m if the GBP 5y rate increases by 35bp above its 3m5y forward (39bp above the spot).

Once a payer spread is sufficiently in the money, it becomes vega-negative and theta positive (see 2nd graph). A decrease of GBP vol, likely in a case of a Bremain vote, would then on margin improve the mark to market of the trade.

The GBP leg starts being short vega and long theta if the GBP 5y moves to roughly halfway between payer spread strikes.

The potential risks could be the massive spike in EUR rates, the strategy is exposed to unlimited losses at expiry if the EUR 3y2y rate moves up by more than 35.5bp (30bp width of the payer spread plus 5.5bp 3m3y2y rolldown) - above the levels was last seen before 21 January ECB meeting.