In our recent posts, we’ve emphasized the significance of the GBP risk reversal expressions precisely both for short-term as well as long-term basis.

GBP weakness is at the forefront of G10 FX markets as Brexit politics has heated up.

The macro strategies have slashed the sterling forecasts recently as UK politics is increasingly leaning towards a hard Brexit, which raises odds of a larger-than-expected hit to medium term growth and risks worsening an already challenging BoP deficit; we now expect year-end levels of 1.21 on cable and 0.95 on EUR/GBP.

In our view, option expressions of GBP weakness are best expressed in a risk-reversal-lite format, since ATM vols have already richened to levels where the risk-reward of fresh longs is questionable.

In contrast, riskies are more affordable (see above chart), cheap on a variety of valuation metrics and have been performing handsomely (glance through the table).

One constraint on buying risk-reversals outright is spec investor positioning which has widened back out to multi-year extremes of shorts on GBP IMMs after a few weeks of risk reduction mid-summer, and can serve to limit the pace of sterling depreciation.

For directional investors, two option expressions that benefit from contained pound weakness resulting from such a positioning set-up yet retain a small long risk-reversal exposure are:

i) Seagulls: e.g. long 3M 1.20 – 1.15 cable put spreads financed by selling 1.30 strike GBP calls/USD puts cost 55bp GBP in premium (spot ref. 1.2236, vs. 172bp on the standalone 1.20 and 100bp for the 1.20-1.15 put spread).

ii) At-expiry digital risk-reversals: admittedly very little skew exposure to such spreads but satisfy the basic criterion of selling relatively expensive GBP calls for financing purposes; long 3M 1.20 GBP put/USD call digital vs. short 3M 1.28 GBP call/USD put digital costs 10% GBP (spot ref: 1.2236, vs.34% GBP for the 1.20 strike).