Hedging GBP costlier due to high volatility amid British polls

The safeguarding cost of GBP against big swings in the next week bubbled to its highest since the May 2010 British elections on Tuesday, just two days before Britons vote in the closest-fought electoral race in recent history.

The last week's GBP/USD options expiring on May 12 implied volatility rose to 18.375%. It is the highest since the results of 2010's UK elections which gave the hung parliament for the UK as no majority evidenced and led to several days of squabbling between parties to form a coalition.

UK Polls on this Thursday's vote explains the ruling Conservatives and the main opposition Labour Party neck-and-neck, while support for Scotland's nationalist party has surged, making another hung parliament the most likely outcome.

Derivatives watch:
Option Strategy: Short butterfly (EUR/GBP)

High volatility is stimulating the GBP upswings on the verge of general elections.

Those who would see this event as largely non directional should short a butterfly.

Expect the underlying currency to move a large move higher or lower but not sure of direction.

Established using all calls or puts and is done for a net credit. 

Although it carries high risk premium, this is best suitable in current sensitive circumstance wherein trader sells one call with a low exercise price (OTM), sells another call with higher exercise price (ITM) and buys 2 Calls with an intermediate exercise price (ATM).

The cost of hedging is the difference in exercise price of ATM calls and exercise price of ITM &OTM calls minus total credit received.

On the contrary the maximum gains could be to the extent of total credit received.

As option values are based on the movements in the underlying stock, it can be used in conjunction with an existing long position to lock in a profit, hedge or limit a potential loss or create an additional Profit or leverage.