October 31, 2018 / 12:20 PM / 19 days ago

Traders most negative on pound since 2016 as Brexit risks mount

LONDON (Reuters) - Traders hold a more negative view on the outlook for the pound than at any time since shortly after the Brexit referendum in 2016, according to options markets, as fears grow that Britain is headed for a sudden, disruptive exit from the European Union.

FILE PHOTO - An employee is seen walking over a mosaic of pound sterling symbols set in the floor of the front hall of the Bank of England in London, in this March 25, 2008 file photograph. REUTERS/Luke Macgregor/files

Financial options knows as risk reversals - which measure demand for options that give investors the right to sell sterling at a future date versus options that give them the right to buy - show traders are increasingly concerned about the pound tumbling between December and April.

Fears of a no-deal Brexit have intensified as talks towards an agreement between London and Brussels over the terms of their divorce hit an impasse.

Sterling neared 15-month lows under $1.27 on Tuesday after Standard & Poor’s warned Britain it was likely to endure a long recession with a no-deal Brexit. The currency recovered slightly on Wednesday.

Even if Britain can agree a deal, Prime Minister Theresa May will need to get parliamentary approval — far from guaranteed given her Conservative party lacks a majority and factions within her party oppose her approach.

Any delay would leave Britain perilously close to its scheduled EU departure date of March 29.

And a parliamentary rejection could plunge Britain into a sudden, disruptive exit, reaping havoc on the economy as the UK fell back on World Trade Organization rules for trade with the EU, its largest trading partner.

Paul O’Connor, head of the UK multi-asset team at Janus Henderson, said any relief for the pound would be short-lived should the EU and Britain agree a deal at a special November summit.

The arithmetic did not favour May getting an agreement through parliament, he said. A failure at the first attempt would spark weeks of “acrimonious posturing, brinkmanship, threats, people worrying about a leadership contest, general election, Jeremy Corbyn” just as liquidity thinned at year-end, he added. Corbyn is leader of the opposition Labour Party.

“So it’s quite plausible that we go into Christmas with a first vote failed and the focus of the second attempt being something to look forward into the new year. That’s not great,” he said, adding that he expected a deal to pass through parliament eventually.

SIMILAR STRESS TO 2016

Investors use option markets to speculate on a currency’s direction, and companies to hedge against adverse moves.

According to FENICS data, three and six-month risk reversals this month hit their highest level since July 2016, shortly after the June referendum vote. That indicates greater demand for put (right to sell sterling) options versus calls (right to buy).

Simon Derrick, BNY Mellon’s chief currencies strategist, noted that six-month risk-reversal pricing “indicates a similar level of stress to that seen in the market in February 2016 as the referendum campaign first began to heat up.”

One-month risk reversals, however, are only at their highest levels since June 2017, suggesting investors are not as panicked about the very short-term outlook for the pound as they are over the outlook into 2019.

Implied volatility - predictions of expected price swings in the pound - are also rising.

There are signs of growing stress in options markets for trading sterling against the euro, too.

Three-month and six-month risk reversals headed this month towards levels seen in August, when bearish sentiment on the pound was at its highest since October 2016.

Additional reporting by Helen Reid; Editing by Peter Graff

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