FxWirePro: Brexit And Covid Viruses Engulf Sterling’s Prospects – Deploy GBP/USD Option Strategy As OTC Bids Indicate Renewed Weakness

The British government remains stubborn and does not want to extend the transition period beyond the end of the year despite the corona crisis and an appeal from the IMF. For the time being Sterling traders remain relaxed though. The experience of the last few years has taught that when it comes to Brexit, an agreement can only be achieved under the greatest pressure and at the very last minute. 

Moreover Boris Johnson’s government once before promised solemnly not to postpone Brexit and then did so after all. It is therefore quite understandable that many market participants assume that Johnson is only bluffing again. The application for an extension of the transition period has to be submitted by July so from the market’s point of view pressure should still be limited for now.

However, there is one important difference compared with last autumn. At the time the government postponed the Brexit deadline from October to January under severe pressure from Parliament, but since the Tories regained the majority in Parliament in the elections at the end of last year Johnson is now likely to have full support as far as Brexit is concerned. Short term Sterling may remain under the control of the corona crisis. However, unless the government caves in beforehand and postpones the negotiations about a free trade agreement with the EU, pressure on Sterling is going to mount in June at the latest due to the increased risk of a hard Brexit.

Brexit is being overshadowed, this is only temporary and GBP remains vulnerable from a great sense of realism amongst investors about the government's objectives for the EU trade talks and its credible threat still to walk away in the pursuit of regulatory autonomy from the EU and freedom from strict level playing field commitments. As a result of the Brexit-virus one-two we are lowering the GBP forecast.

Options Strategy (Debit Put Spread): Contemplating above factors, wise to deploy diagonal options strategy by adding short sterling: Stay short a 2M/2W GBPUSD put spread (1.25/1.14), spot reference: 1.2435 level. 

The Rationale: Observe the 3m GBP’s positive skewness that has stretched towards OTM Put strikes upto 1.18 levels, hence, options traders are expecting that the underlying spot FX to slide southwards. 

To substantiate the downside risk sentiment, risk reversal numbers have still been signalling bearish hedging sentiments in the long run. One can observe fresh negative bids that indicates hedgers have shown renewed interests for bearish risks in the months to come.

Hence, we advocate the diagonal options strategy on both hedging and trading grounds. Courtesy: Sentry, Saxo & Commerzbank