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Weakening Sterling Prompts Investors To Buy Puts

One-month cable implied volatility rose and risk reversals moved further in favor of sterling puts/dollar calls last week as investors continued to speculate that the pound would weaken against the dollar. One-month implied volatility ticked higher to 7.5% last Wednesday, up from around 7% a week earlier. Foreign exchange options traders in New York reported that the options were typically at the money, while spot was trading around USD1.43. The rise in volatility was attributed to comments made by John Townend, director of Europe for the Bank of England, who said the pound was overvalued against the euro. Some investors thought Townend's comments would help to strengthen the pound because they seemed to imply that the U.K. is still a long way from euro entry.

Bob Gay, global head of fixed income research at Commerzbank Securities in New York, said sterling would sustain its weakness until investors were certain of no further cuts in short-term interest rates in the U.K. "When the uncertainty ends the differential will begin to ease," Gay noted. Gay also predicted that it would be another year before the U.K. makes a euro entry because a majority of the public is against the move and the economy is still out of sync with the rest of Europe. "The U.K. has a strong gross national product and its overall economy is doing much better than Europe's. To make the move right now would be bad timing and the public senses that," he said.

GBP/USD Spot & One-Month Implied Volatility

Source: J.P. Morgan

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