How To Trade Brexit

As JPMorgan said yesterday, "opinion polls ahead of next week’s referendum have made a powerful move toward Brexit (Figure 1)" adding that its attempts to clean up the polls for methodological issues suggests a lead for leave in the 3%-5%-pt range at the time of writing."

And yet, despite the dramatic shift in polls, UK bookmakers are still predicting a victory for "Bremain" at roughly 65% odds (we can only assume here that the banks, all of which are extremely motivated for Remain to win aren't dumping massive amounts of money for "remain" in order to reflexively sway public opinion). 

With several key polls due in the coming days - and following the murder of Jo Cox -  JPM adds that prior referenda suggest a swing toward the status quo is often seen, both in polling over the final two weeks of the campaign and in comparing the result with final projections from the polls. In the Scottish independence referendum, for example, polls made a small move back toward remain ahead of the vote, and the eventual 10%-pt win for remain compared to an average

Deutsche Bank points out something comparable. Jim Reid notes that "while we are not pollsters so find it impossible to understand the biases that might be there it's interesting to graph the opinion poll leads for the Scottish referendum in September 2014, the Quebec referendum in 1995, and that of the current UK vote."

Looking at the chart below...


... Deutsche observes that "the status quo of 'remain' saw its lead progressively reduce in all three as referendum day approached. The big difference in Scotland was that apart from two shock polls one and two weeks out, 'remain' stayed comfortably in the lead in every other poll. In Quebec the lead and momentum for 'leave' was similar to that seen recently in the UK with the exception of one even bigger lead for UK 'leave' this past weekend. The average lead of the last 3-4 days of polls before the vote was around 4% for 'remain' in Scotland. However the actual result saw a 10.6% win for 'remain'. In Quebec the equivalent numbers were a 5% lead for 'leave' but a 1.2% win for 'remain'. So polls effectively showed a 6% final swing back towards 'remain' or there was polling error. We'll never know which and we won't know until next week whether history repeats."

This may explain why bookies haven't flipped yet: "one can see why the 'leave' lead might need to appear to be more than 5% for there to be high confidence that this will be the final result."

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So while it is still practically impossible to forecast either outcome, here are some thoughts from BofA on how to trade Brexit, regardless of which way the final vote goes.

  • June has already been a Brexit trade as precious metals, bonds, and credit rallied while equities fell. Watch GBP, bund yields, and Euro bank stocks after the vote. If GBPUSD can hold 1.39 the risk-off Brexit trade is likely to reverse. Note in the 1976 IMF crisis & the 1992 ERM crisis a low in sterling was the catalyst for a marked change in market direction of UK assets.

In a little more detail:

  • on a Brexit vote: long gold, short peripheral debt versus bunds, long EUR vol vs GBP, short volatility/long risk once sterling troughs. With GBP options priced above 2008 extremes (31% then vs. 39% now) and FTSE options at the 98th percentile of 10-year ranks, short volatility after a market decline by selling GBP and UKX puts. Hedge potential aftershocks in Spanish and Italian elections with V2X call spreads and EUR vol. Additionally, consider buying UK stocks that derive a large percentage of their sales from the US and/or UK midcaps, which are trading at 4.5-year relative lows vs. European peers.
  • on “Bremain”: long DM equities for the bearish positioning unwind and short volatility immediately; short Spanish & Italian bonds vs. gilts; take a closer grip on the barbell. S&P 500 options are now visibly pricing in Brexit risk, so expect the term structure to normalize and short volatility by selling SPX puts or buying VIX puts along with the bullish UK trades above. Political event risk will remain for peripheral Europe, so short Spain and Italy, replacing bunds with gilts as foreign investors pile back into UK debt.