Carney takes Brexit option fears to prime time
Bank of England governor Mark Carney confirmed to the UK parliament on Tuesday what currency traders and analysts have been saying for weeks: worries about the EU referendum are causing higher prices for sterling options and raising the risk of a sharp fall in the pound.
"In terms of the implications of the referendum, we have seen a marked increase in volatility in the options market around the date of the referendum, once the date became known, and the skews in the options market...have gone up quite sharply, above levels that were seen during the Scottish referendum," he said.
Carney suggested that an exit from the EU could cause short term instability in the financial system. It would also be likely to persuade some financial institutions to leave London, he said.
In an update to its scenario outlook, the Morgan Stanley European economics and strategy team said that MSCI Europe equities could fall 15-20% on a Brexit outcome, with greater risk in the stocks of the UK, Eastern Europe, and the periphery. Central and European companies would be exposed via trade, said the analysts.
Positioning for softer growth expectations across Europe following a British exit vote is not easy or expensive.
"Hedging or positioning for such a de-rating is a challenge when Eurostoxx implied volatility is already 5-6% above the long-run median in the aftermath of a global growth scare," said Morgan Stanley strategist Phanikiran Naraparaju.
To cheapen the cost of a hedge, Naraparaju suggested buying equity puts conditional on a weaker euro.
"For instance, a June 2016 expiry SX5E ATM put contingent on EUR/USD below 1.1 (spot) costs 1.5% versus 5.2% for vanilla at-the-money put,” he proposed. “That’s a significant saving."