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Foreign Exchange

EURGBP in limbo; profit with short-volatility trade, says JPMorgan

The EURGBP cross rate is caught in limbo because both the eurozone and the UK economies face significant short-term economic risks, which are reflected in the views of their currencies. That means the cross rate should remain within a relatively tight trading band in the coming months, say JPMorgan option strategists in a research note.

On one hand, JPMorgan is bearish on sterling, “reflecting the not insubstantial risks of a unilateral double-dip in the UK economy”. Still, those concerns must be set against the “fiscal drama in the eurozone”, argues Paul Meggyesi, an analyst at JPMorgan in London. As a result, he concludes that the cross rate will probably remain range-bound for the next month or so as the market weighs up the balance of these two forces.

During this period, Meggyesi recommends investors adopt a short-volatility strategy that takes advantage of a narrow trading band and the heightened levels of implied volatility that have occurred this month. This volatility has resulted from the unexpected extension of Europe’s crisis of confidence to Italy in recent weeks, and the continued gridlock in Washington with regard to the lifting of the US debt ceiling.

“We see little merit in holding directional risk,” writes Meggyesi in the note. “Our preference remains to trade the range in high-beta currencies, where there are gravitational forces acting to hold spot in a tight range.”

Given that EURGBP trading is likely to remain range-bound over the coming weeks, traders looking to benefit from this stasis should buy two-month 0.8550-0.9100 double-no-touch EURGBP options, says the analyst. Based on a spot rate of 0.8785, for a price of 25.5% of face value, investors can earn a payoff of 100% if the cross rate does not touch either 0.8550 or 0.9100.

Meggyesi skews the trade recommendation to the top side, because a break in EURGBP, when it comes, is expected to be to the topside, he says.

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