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GBP/USD – Is the Options Market Underpricing Brexit Uncertainty?

GBP/USD – Is the Options Market Underpricing Brexit Uncertainty?

Paul Robinson,

What’s inside:

  • One-week implied volatility rises to 10.19%, but below prior peaks this year
  • This could perhaps indicate an underpricing of what is an eventful few days with Brexit talks
  • Projected levels and how they stack up against the technical backdrop

Find out how markets are expected to end the final weeks of the year in the DailyFX Trading Guides

In the following table, you’ll find implied volatility (IV) levels for major USD-pairs looking out over the next one-week and one-month periods. We’ve made not of the differentials, which can help shape expectations and/or identify currency pairs where the options market may be mispricing potential price movement in the short-term. Also outlined, are projected range-low/high prices from the current spot price within one-standard deviation of the current spot price looking out over the next week. (In theory, there is a 68% probability that price will remain within the lower and upper-bounds.)

Implied volatility with levels

GBP/USD 1-wk implied volatility rises above 10%, but is it still too low?

GBP/USD one-week implied volatility (IV) is on the rise, currently at 10.19% and materially higher than one-month IV which is at 8.23%. The higher short-term premium reflects the fact that the UK has until Friday to make a recommendation to the EU council. The council is to then decide on December 15th whether to allow Brexit talks to continue on to phase II.

Markets appear to be fairly complacent that a deal will be struck. We’ve seen 1-wk implied volatility at much higher levels this year; 11.6% in September, 14.3% in June, and 15.8% in January. This begs the question, are traders underpricing the impact of events over the next few days? In recent days trading has become more volatile reflecting growing uncertainty and thus the rise in options premiums. But is it still too low? Traders certainly don’t seem too concerned. The overall trend in the price of cable since early November (and the year, for that matter) has been higher and thus reflects an expectation for a positive outcome. With that said, should talks fall apart the risk of a big plunge doesn’t look to be priced in. Market mispricing leads to market dislocations.

Based on current levels of implied volatility, the projected 1-stdev range low/high for the next week is 13204-13584. The technical outlook still remains somewhat favorable, with the 2014 trend-line having been recently exceeded (it crosses over the Brexit-high and spike-high in September). It is currently under a retest and if broken the area right around 13300 will quickly come into view. Trend-lines rising up from March and April lie down near the projected one-week low. If all the aforementioned lines are broken in the days ahead then things are not turning out as the market is currently pricing. On the top-side, GBP/USD has last week’s high at 13550 to contend with (in alignment with the projected weekly high), then the September spike-high at 13660 remains the big hurdle to be crossed before we can see a broader move take shape.

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GBP/USD: Daily

For other currency volatility-related articles please visit the Binaries page.

---Written by Paul Robinson, Market Analyst

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You can follow Paul on Twitter at @PaulRobinonFX.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.