Risk reversals: Demand for GBP puts/USD calls have spiked on fears of UK exit from the EU.
The likelihood of the significant 'brexit' will likely keep pressure on the UK currency through the foreseeable future, while key events in the week ahead could force significant short-term volatility.
3M IV is trading at 15.23%, which is highest level in last 70 months, IV touched 16.9% in May 2010, when Prime Minister Cameron was suffering coalition issues post-election. With the adjustment to the IVs, risk reversals and next significant event that can have the major impact on GBPUSD would be UK referendum (that is scheduled 2 months from now).
Pound just snapped back from critical low against Dollar today around 1.406 area but price actions clearly suggests vulnerabilities remain. Over the past five days, Pound has dropped more than 400 pips against Dollar.
We would still recommend a GBP/USD 3M risk reversal i/o 1Y as a generic hedge for Brexit risk. The ideal entry point is not ideal given the near doubling of the risk reversal since early October, but the bias is for further widening of the skew in 1H on slow-bleed demand for event protection.
As the risk reversals for 1W-1M expiries also indicate that the puts have been relatively expensive and as stated above traders are willing to pay higher implied volatility prices as the strike price grows aggressively out of the money.
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