Last week I was putting together some quotes for a client who asked for a hedge using foreign exchange options. Most of our clients use standard forward contracts where we can lock in a price for an FX transaction today to be settled at some time in the future. But this client wanted to buy a contract that protected against a fall in British pounds sterling and offset the cost by selling a contract that protects against a rise in sterling.
When I priced the contract, I was taken aback by how much more costly the contract was to protect that fall in sterling than it was to protect against a sterling rise. I spoke to an options trader at our parent company, Royal Bank of Canada, to verify pricing accuracy. He confirmed, adding that liquidity in British pound sterling options is currently very low.
Understanding the direction of currency movements is never easy, but it is particularly difficult with the British pound right now. It is just pure "headline risk" and the possible outcomes are binary – either there will be a Brexit deal or not. There is no in-between. Headlines indicating there might be a deal send sterling higher and those indicating otherwise send the pound lower.
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