October 30, 2019 / 9:52 AM / 16 days ago

Sterling drifts as big options reduce volatility

LONDON (Reuters) - Sterling edged higher on Wednesday after British Prime Minister Boris Johnson won parliamentary approval to hold a general election in December, though moves were limited as large currency options expiring this week curbed volatility.

FILE PHOTO: British Pound Sterling banknotes are seen at the Money Service Austria company's headquarters in Vienna, Austria, November 16, 2017. REUTERS/Leonhard Foeger

More than $2 billion worth of options with a strike price of around $1.29 and billions more between $1.24 to $1.32 are expiring on Oct. 31, an original Brexit deadline, according to Refinitiv data.

Graphic: World forex rates in 2019 -tmsnrt.rs/2egbfVh

Graphic: Trade-weighted sterling since Brexit vote - tmsnrt.rs/2hwV9Hv

The presence of such large derivatives contracts means banks and hedge funds will try to reduce overall market volatility in the pound as it could otherwise trigger these massive options and unleash large market moves.

As a result, overall market volatility in the pound has dropped to less than 7%, more than halving from a peak of 14% earlier this month, a near 2019 high.

Johnson, who has failed to deliver on his “do or die” promise that Britain would leave the EU on Oct. 31, secured the election agreement for mid-December just hours after the EU granted a third delay to Brexit.

“Johnson has cross-party support and (the opposition) Labour Party has lost a fair lot of the credibility it had in the 2017 election,” Derek Halpenny, European head of global markets research at MUFG, said.

“So that’s reflected in the stability in sterling - markets believe the Conservative party will hold on to power and have a Brexit deal agreed with the EU.”

The pound was broadly flat against both the euro, at 86.40 pence, and the dollar, at $1.2869, as the market assessed risks associated with the Dec. 12 election.

The outcome of a U.S. Federal Reserve meeting later on Wednesday is also limiting overall market volatility.

The pound has rallied almost 5% so far in October, boosted in the week leading up to the EU summit where a new Brexit deal was approved. Johnson pushed for the election in response to being unable to get this deal through parliament.

While the risk of a no-deal Brexit has been taken off the table by most analysts, there is a chance that a Conservative election win could embolden hardline Brexit elements of the party to push for a more disruptive break from the EU.

“It is not certain whether the deeply divided electorate will give a clear mandate for a particular direction in the Brexit process,” Commerzbank analyst Antje Praefcke said in a note.

Michael Hewson, chief market strategist at CMC Markets, said: “The pound will move on any move in opinion polls between now and the election. Whether we get a hung parliament or a Corbyn (Labour) majority or a Tory (Conservative) majority is not clear.”

“(The) pound is likely to trade (between) $1.25 and $1.30 between now and then but it will be a bumpy ride,” he said.

Graphic: Option expiries - here

Reporting by Elizabeth Howcroft; Additional reporting and graphic by Saikat Chatterjee; Editing by Ken Ferris and Mark Potter

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