Foreign exchange and interest-rate derivatives strategists are throwing together plays on euro/sterling after Britain's largely pro-European Labour Party won a second five-year term in last month's general election.
Lehman Brothers and Barclays Capital are pitching trades in the foreign exchange and interest rate markets, respectively, that are designed to win if the pound depreciates to a level at which it could join the euro, while BNP Paribas predicts sterling will rebound, which would effectively take membership of the single currency off the agenda.
Francesca Fornasari, foreign exchange strategist at Lehman in London, thinks a pro-euro campaign by the government could swing public opinion in favor of joining. Lehman recommends investors enter a three-year call spread in which they buy a euro call/sterling put struck at GBP0.64 and sell a call struck at GBP0.69. The cost of this is off set by selling a fade-in euro put/sterling call struck at GBP0.60, according toAnne Sanciaume, another foreign exchange strategist in London.
Lehman set the strike on the sterling put at GBP0.69 because it expects sterling to enter the euro at a value between GBP0.67 and GBP0.71, Sanciaume explained. Euro/sterling spot was trading at GBP0.6030 on Friday.
This view is not shared by Ian Stannard, foreign exchange strategist at BNP Paribas in London, who thinks the convergence story is being over played. He expects sterling to continue falling as funds flow out of the U.K. in anticipation of pension fund deregulation.
Sterling will enter the euro in the long-term, suggests John Maskell, director in European strategy at Barclays Capital in London. To take advantage of this view, the firm is pitching a pair of interest-rate swaption trades that benefit from convergence while taking advantage of any short-term divergence. In the divergence trade clients buy a two-year option to enter a five-year sterling payer interest-rate swap and sell an identical option in euros.
In the convergence trade clients buy a two-year option to enter a 30-year euro receiver swap and sell the same option in sterling. When both trades are put on the position is almost cash neutral.