http://themacrotourist.com/images/FinalJun1316.png

Over the past couple of weeks British Pound option traders have faced a wall of gamma buying. Implied volatility for near term CME pound options has doubled from 14% to 28%!

http://themacrotourist.com/images/BPJun1316.png

Worries over Brexit has pushed up the cost of insuring against large moves in the Pound to levels last seen during the 2008 credit crisis.

http://themacrotourist.com/images/LTBPJun1316.png

Yet even though implied volatility is pushing 30%, actual sterling volatility has been fairly muted. 10 and 30 day historical volatility is running around 10%.

Although we all know there will be some fireworks on the day of the vote regardless of the outcome, at these levels, pound volatility is a great sale.

The CME 1.415 straddle that expires on July 8th, 2016 is trading for 9.75 points. That equates to an almost 7% premium for options that expire in less than a month.

The level of worry about a leave result has created an environment where everyone concerned about potential fall out, has already sold. I am going to shamelessly steal two great charts that Dave Lutz from Jones Trading highlighted this morning that illustrates this point perfectly:

http://themacrotourist.com/images/Dave1Jun1316.png

http://themacrotourist.com/images/Dave2Jun1316.png

This is shaping up to be a perfect sell the rumour, buy the news situation.

Meanwhile, the Yen continues to appreciate. Most worrisome for Kuroda, the Euro/Yen cross rate keeps declining (meaning weaker Euro relative to Yen).

http://themacrotourist.com/images/EURJPYJun1316.png

Japan cannot afford to allow their biggest export competitor to continue cheapening its currency relative to the Yen. Kuroda will not sit idly by and allow this cross rate to weaken.

Although everyone is focused on the potential large moves resulting from the Brexit vote, few are paying attention to the fact the Bank of Japan has a meeting this week. Whereas Pound vol is excessively expensive, Japanese Yen volatility is trading right on top of recent historical levels.

http://themacrotourist.com/images/YenJun1316.png

I am shorting British Pound currency volatility and I pairing it with a long Yen volatility position. Although I am not taking a big delta bet, I am structuring the positions with the thought the surprise jump will be to the downside on the Yen, and to the upside on the Pound.

I know this is a little more technical than many of my other posts, but if you aren’t an option trader and want it synthesized down; there is too much worry about Brexit and not nearly enough acknowledgement Japan might surprise with more stimulus. This is almost the exact opposite of what the market believes… And that is why it pays to take the other side of the trade.


Interesting relationship

This morning Joe Weisenthal from Bloomberg News tweeted this great chart of the S&P 500 versus GBP/CHF cross rate:

http://themacrotourist.com/images/JoeJun1316.jpg

Obviously trading in risk assets is being unduly influenced by Brexit concerns. Be careful with your short positions. We are getting closer to the point where Brexit is completely baked in, and the surprise will be a S&P 500 that climbs back up, not the other way round. Combine this nutbar LinkedIn acquisition with further Japanese stimulus, and it wouldn’t take much for stocks to scream back to new highs.

Thanks for reading,
Kevin Muir
the MacroTourist