Options Cost to Hedge Pound Surges Before Scotland Ballot

By Neal Armstrong

The cost of hedging against a weaker pound via options has risen as Scotland’s referendum looms.
For the first time in more than a year, investors need to pay more for protection against a weaker U.K. currency versus the euro than a stronger one. The shift came as gauges of future price swings for the pound surged this week after a survey showed support for Scottish independence is increasing before the Sept. 18 vote. Sterling rose versus the euro after the Bank of England kept its key interest rate at a record low and the European Central Bank unexpectedly lowered its borrowing costs.
“This is essentially positioning linked to
the Sept. 18 risk event,” said Olivier Korber, a derivatives strategist at Societe General SA in Paris, referring to the move in euro-sterling options. “Front-end sterling volatility is discounting the risk of a ‘Yes,’ since the polls are narrowing.”

Scotland’s Bid for Independence

The premium traders pay for one-month options to lock in a price to sell sterling against the euro versus those allowing for purchases at that level was 0.15 percentage point today, 25-delta risk reversals show. It rose above zero two days ago for the first time since August 2013, showing increasing speculation that sterling will fall.
A positive reading shows the price of a sterling put, or a bet on a weaker pound, exceeds the cost of a sterling call, or a bet on a stronger U.K. currency.

‘Yes’ Sentiment

Sentiment has strengthened in favor of independence, according to a YouGov poll published in the Times and Sun newspapers on Sept. 2.
Stripping out respondents who were undecided or wouldn’t vote, the latest poll found 53 percent would vote against independence, down from 57 percent about two weeks earlier, with 47 percent in favor, up from 43 percent. The six-point deficit had narrowed from 14 points in the last YouGov poll conducted on Aug. 12-15. The recent poll surveyed 1,063 people, according to YouGov.
The nine members of the BOE’s Monetary Policy Committee held interest rates at 0.5 percent, as forecast by all 49 economists in a Bloomberg News survey. While committee officials split last month, with two saying a strengthening labor market warranted higher borrowing costs, derivatives show investors are only fully pricing in an increase by May.

Maturing Debt

The MPC also announced plans to reinvest 14.4 billion pounds of maturing debt acquired as part of a 375 billion pound asset-purchase program.
Sterling strengthened 0.6 percent to 79.40 pence per euro. The pound fell 0.2 percent to $1.6425 after dropping to $1.6423, the lowest level since Feb. 11. U.K. government bonds were little changed, with the 10-year yield at 2.47 percent.
The ECB lowered its benchmark rate 10 basis points to 0.05 percent, a decision predicted by just six of 57 economists surveyed by Bloomberg.
East Lodge Capital Partners LLP is buying protection against losses on U.K. government debt and the pound, according to a person familiar with the matter. The London-based hedge fund has also taken short positions in Royal Bank of Scotland Group Plc, betting the stock will decline if Scotland calls time on the nation’s 307-year-old union with England and Wales, said the person, who asked not to be identified.
The pound fell 1.4 percent in the past month, the worst performer among 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro fell 1.8 percent and the dollar gained 1.6 percent.