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Bullish/bearish scenarios of Sterling amid brexit deadlock - GBP/USD OTC indications and hedging perspective

Bearish GBPUSD scenarios: 

1) A no-deal Brexit (GBP -10%). 

2) PM May resigns and/or is replaced by a harder-Brexiteer following the defeat of a Brexit motion in parliament, opening way to #1.

Bullish GBPUSD scenarios:

1) A negotiated Brexit which includes a political declaration supporting a soft-Brexit (Norway-model). 

2) Defeat of a Brexit motion in parliament causes the government to fall, paving wave for a general election and/or a second referendum and potentially no Brexit.

Sterling’s implications in the near term: Primarily, the indication that the UK and the EU are closer to an agreement than perceived markets, which has come to light now that the budget is set to be passed. It is reckoned that increasingly likely that a deal would be finalized by the December 13-14 council meeting. Secondarily, news reports indicated a favorable outcome for UK in relation to financial services (British banks could get access to the EU after Brexit). 

OTC outlook and options trading perspective:

Positively skewed GBPUSD implied volatilities of 3m tenors still signal bearish hedging sentiments. To substantiate this downside risk sentiment, risk reversals have also been in negative territory.

We reckon that the sterling should not suffer like before, but, one should not disregard Fed’s hiking cycle on the other hand. The market has always ignored the fact that all the current BoE interest rate moves are due to a favourable result of the Brexit process.

Both the speculators and hedgers of GBPUSD are advised to capitalize on the prevailing price rallies for bearish risks and bidding theta shorts in short run (1m IVs) and 3m risks reversals to optimally utilize delta longs.

On hedging grounds, fresh delta longs for long-term hedging comprising of ATM instruments and OTM shorts in short-term would optimize the strategy.

So, the execution of hedging positions goes this way:

Short 1m (1%) OTM put option (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, initiate longs in 3m ATM -0.49 delta put options. A move towards the ATM territory increases the Vega, Gamma and Delta which boosts premium.

Thereby, the above positions address both upswings that are prevailing in short run and bearish risks in long run by delta longs.

The political and economic backdrop remains supportive of sterling’s underperformance. We continue to be short but take partial profits by unwinding the GBPUSD expression of the trade since this is currently in the money but has only less than a week to expiry and is close to the strike. 

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards 58 levels (which is bullish), and hourly USD spot index has bearish index is creeping at -12 (mildly bearish) while articulating (at 06:48 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex

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