Using British pound options to play a dovish BoE

As the Bank of England (BoE) continues its efforts to push inflation back to its 2% target, the pound Sterling has fallen to near 31-month lows against the dollar. With the Bank of England considering another round of QE, and some members of the FOMC expressing more hawkish sentiment, how much more can the pound slide? Britain’s economy appears to be in a state of sluggish recovery, and  with unemployment data improving and many economists questioning if more easing would boost growth, will the BoE follow through with another round of asset purchases?

The Bank of England governor Mervyn King recently pushed for the scale of the asset purchases to be increased from 375 billion pounds to 400 billion. However the Monetary Policy Committee (MPC) minutes revealed that although they voted against more easing, there is a likelihood of increased asset purchasing later. The vote against expanding the program was not a landslide. The Committee voted 6-3 against more easing. The market responded with a sharp selloff on the release of the minutes. When the Committee last had a split vote, easing was expanded later in the year.

With the release of the hawkish FOMC minutes and the dovish MPC minutes, it is likely that the pound will continue to see some downside through the rest of the year.  So if a trader had a short view of the pound how could they set up a trade?

  1. Sell spot pound Sterling. Although a trader can get good leverage in the forex market, this could be capital intensive and would require a trader to use wide stops. Trading the spot forex market does not allow a trader to set up a well-defined risk vs. reward ratio.
  2. Short the ETF. The CurrencyShares British Pound Ster. Trst (FXB) does an excellent job of tracking the performance of the underlying, but shorting the ETF would require significant margin. This also does not set up well on a risk vs. reward basis.
  3. British pound Futures and Options. Follows the spot market and gives a trader the best opportunity to set up a trade with a great risk vs. reward ratio.

The Trade:

Buying the /6B Mar 1.51-1.50 Put Spread for $.0025
Risk: $156.25 per 1 lot
Reward: $468.75 per 1 lot
Breakeven: 1.5075

The options market is implying that the futures could fall another .02 by March expiration right to the level where this trade sees a maximum profit. This trade also sets up for a great risk vs. reward ratio.

Click to enlarge.

About the Author
James Ramelli

James Ramelli is the Moderator of the Live Futures Options Trading Room at KeeneOnTheMarket.com where he actively trades futures and options on futures while educating members on strategies, setups and risk management. He has a degree in Finance with a focus in Derivatives Trading and Financial Engineering from The University of Illinois and has been trading for five years. James appears regularly on Bloomberg T.V. and BNN and writes a weekly column for Futures Magazine.

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