SocGen: "The Pound Short Covering May Just Be Starting"

Tyler Durden's picture

One day after Deutsche Bank quickly flipped its bearish outlook on the British pound after Theresa May announced snap elections in June, calling the announcement a "gamechanger" and saying "we have been structurally bearish on sterling for the last two years but are now changing view. We are closing out all our bearish FX trades", today it was SocGen's turn to ask rhetorically if "the worst may be behind us and cable short covering may just be starting."

 In short: another bank has flipped bullish and is urging clients to squeeze cable shorts, only instead of doing it directly by buying GBPUSD outright, SocGen comes up with a novel trade, specifically one in which SocGen recommends selling downside and volatility as follows:

Buy GBP/USD 3m seagull strikes 1.24/1.32/1.35; Zero cost (indicative, spot ref: 1.2850); The strategy has an initial delta of about 35%, is short vega, and almost no theta on the upside.; The market value is hurt if the spot falls but recovers to flat provided that the spot is above 1.24.


A key objective going forward is 1.3450/1.3505.

Here are the full details:

GBP/USD: Is the worst behind us?

Rationalte: Brexit negotiations: better prospects

Prime Minister May surprised the market by calling for a snap general election on 8 June. The possibility of a hard Brexit has already been discounted by the market, but the larger parliamentary majority currently implied by the polls (chart below) would strengthen the UK government's negotiating position domestically. The market is now assigning better odds to a post-Brexit EU-UK trade agreement, and thus the worst may be behind us and cable short covering may just be starting.

- Positions set to shift

The options market is seeing a wave of unwinding of medium-term bearish puts as the 1y GBP/USD risk reversal has softened to its lowest level since end-2015. Risk reversals have led the spot positioning in the past, and the latter is still exhibiting extreme shorts.

- Milder economic impact

The freshly released IMF WEO now forecasts UK growth of 2.0% this year, upgrading the January forecast by 0.5%. This reverses nearly all of the downgrade it pencilled in after last summer's Brexit vote (1.1% was forecasted in October).

- Bullish technical signal confirmed

The scenario in the Chart Alert published by our technical analysts materialised overnight, with cable breaking the 1.2780 high. A key objective going forward is 1.3450/1.3505.

Expression - Selling downside and volatility

- The technical/macro/political picture makes us more comfortable financing a call spread via downside options.
- The resulting seagull structure is short volatility, consistent with the view of a higher spot on the back of a brighter economic outlook and reduced political risks.

Mechanics - Buy GBP/USD 3m seagull strikes 1.24/1.32/1.35

Zero cost (indicative, spot ref: 1.2850)

- The strategy has an initial delta of about 35%, is short vega, and almost no theta on the upside.
- The market value is hurt if the spot falls but recovers to flat provided that the spot is above 1.24.

Risks - Unlimited below 1.24, flat between 1.24 and 1.32

Our seagull exposes investors to unlimited downside risk if cable trades below the 1.24 strike in three months.

The trade is flat at expiry between the 1.24 and 1.32 strikes.

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cossack55's picture

Let them eat Pound cake


         Queen Corgi

RadioactiveRant's picture

The election changes nothing, 27 countries still have a veto on any future deal and there are more than 27 grievances that will rise to the surface. Spain wants Gibraltar, Denmark wants fishing rights and there will be more to come. The UK faces a humiliating climb down on everything or it gets no deal. I predict no deal.

Peacefulwarrior's picture

They can threaten a more abrupt slowing down or even default on obligations, which may put them on higher ground with some of the soft handed CB's and Politicians of remaining EU countries.

RadioactiveRant's picture

A default on obligations will likely rile the A8 they'll see their infrastructure grants wither if Britain doesn't pay the exit bill. The EU needs to see exiting countries fail to deter others and the federal institution won't want to look responsible for fear of upsetting individual states - walking away with no deal saying we tried will suit Brussels. There's no positive outcome for the UK.

caesium's picture

May is going for a big win in order to control the crazier Brexiteers in her party. I think then she will sort out some form of bronze membership for the UK as in a downgrade from the present silver membership.

HenryHall's picture

UK has been a net contributor to EU for many years.

That has to stop very soon. Long before exit negotiations approach completion.

The way to stop net contributions is simply to default.


NoWayJose's picture

Baloney. Now we will told that the election is good for the GBP - whatever the result!

quasi_verbatim's picture

When the word goes out that Brexit is DOA the rally will rip any seagull's face off.