FxWirePro: Sterling Looks Weaker On Gloomy Economic & Geopolitical Surface – Deploy ‘Debit Call Spreads’ To Hedge

The Corona crisis has hit the British economy comparatively hard. In addition, Brexit risks remain high, which is why we assume that the pound will continue to remain weak against the euro.

Given that the UK and EU should have a strong interest in the conclusion of a free trade agreement, not least due to the already difficult economic situation caused by the corona crisis, our economists are confident that an agreement on at least a partial trade deal which covers the most important areas remains possible in the next couple of months. Nevertheless, they acknowledge that the probability of a no-deal Brexit has increased significantly. For this reason, we are forecasting a weak pound in the short term and only a very moderate recovery later in the year. In fact, there is a high risk that the pound will suffer much more severe setbacks in the meantime than our forecasts suggest due to rising Brexit risks. Exchange rate volatility is likely to increase particularly towards the end of the year when the UK is due to actually leave the EU single market.

As a result, our defensive stance in EURGBP has been dictated by the receding global economic tide, but we cannot ignore that geopolitical and economic risk has been an instrumental factor in these worse macro outturns. This warrants a tactical reduction in our defensive exposure but we uphold our hedging portfolios via 3-way straddles.

Let’s just quickly glance at OTC updates & suitable options strategy:

The positively skewed IVs of 3m tenors are indicating upside risks, more bids are observed for OTM call strikes up to 0.9250 levels.

While mild bearish hedging setup is observed for the existing EURGBP bullish risk reversal setup across all tenors substantiates upside risks.

Accordingly, at spot reference: 0.9046 levels, we upheld our shorts in GBP on hedging grounds via 3-month (0.89/0.9250) debit call spread. If the scenario outlined above unfolds, we will re-assess our stance but at the moment there are no changes to our GBP recommendations.