EUR/GBP spikes capitalizing on Brexit risks

FX:EURGBP   Euro / British Pound
188 0 2
Our central scenario is that the UK will remain in the EU. Risks of Brexit, however, have increased; the associated transitional costs of Brexit look high.

In FX space, our end-of year forecasts have a sharp H2 recovery in GBP to 1.54 GBP/USD             and 0.7717 EUR/GBP             , but we have a strong conviction that any post referendum bounce in GBP will occur from lower levels than at present.

The risk premium for Brexit in the GBP TWI             is between 1-7% following GBP's worst performance in six years. Still, we see a non-negligible possibility that GBP hedging flows could drive an even larger wedge between sterling and fair-value in coming months. Midyear bearish targets are set at 1.33 GBP/USD             and 0.78 EUR/GBP             .

Technical Glimpse:

EURGBP             has been holding stronger supports at 0.7525 and resistance at 0.7737 at which the price behavior was similar in many times in the past, after taking yesterday's support near moving average, the current prices have jumped well above 21DMA. While, a clear substantiation from other leading indicators which have shown buying sentiments as they converge to the price rallies but beyond 0.7737 would be keenly observed on a closing basis. To justify this bullish outlook huge volume build ups on rallies is also observed.

Please be noted that how delta risk reversal numbers are getting higher positive values gradually over long run (flashing at 1.40 for 1 year expiries) along with implied volatility show that hedgers are willing to pay higher prices for these sentiments as the spot FX is also growing aggressively in the money.

Hedging arrangements: EUR/GBP            

The sterling seems to take a halt on Brexit and euro             on winning streak, the pair is likely to persist its long lasting gaining streaks as per the delta risk reversal computations. So now the pair is making an attempt of recovery a bit as both technical and fundamental indicators are signaling buying sentiments again.

Hence, those who anticipate the underling currency to make a large move higher, then the strategy can be established as follows,

It is better to cover all your shorts and as shown in the diagram purchase 2 lots of call options (one 1M ATM +0.51 delta call, 2M 1% OTM 0.43 delta call) and simultaneously short 1 lot of 3D (0.5%) ITM             call with positive thetas in the ratio of 2:1.

The lower strike short calls because it finances the purchase of the greater number of long calls (ATM calls are overpriced, so we chose shorting 1% ITM             calls with shorter expiry in order to reduce the hedging cost) and the position is entered for the least cost.

The dollar has to make substantial move on the upside for the gains in long calls to overcome the losses in the short calls as the maximum loss is at the long strike.

Give EURGBP             longer time to expiration so as to make a substantial up move but prefer shorter expiries on short side.
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