Is the British pound's sell-off over?

Since 2013 began, British Pound Futures have fallen from highs of above 1.63 to the lowest levels it has seen since 2010 at 1.4823. However, traders have seen the futures rally on recent comments from the Bank of England’s Monetary Policy Committee over concerns about the pound’s free fall. The expectation was for the BOE to step up the size of asset buying programs, but does the recent rally and hawkish comments signal a key reversal for the world’s oldest currency?   

The recent weakness in economic data coming out of British policy makers are worried that the lack of growth coupled with inflation could lead to a deep recession. Mervyn King, BOE governor, had been one of the biggest proponents of a weaker pound hoping to boost Britain’s exports is now saying that the pound has been devalued enough and that more weakness is not necessary.  Yesterday the BOE announced that its inflation target will remain unchanged at 2% year over year hoping to stem the price pressure caused by the currency’s weakness in 2013.

With British Pound futures seeing the strongest week they’ve had all year and the hawkish language from the BOE, the pressure on the pound could be relieved for now. Small beats in consumption numbers out of Britain add to the new bull case for the pound. 

So how can a trader take advantage of the change in tone from the BOE and the shift in price action in the British pound?

Here are the trader’s choices:

  1. Buy spot pound. This is obviously the cleanest way to trade the pound, and also provides a trader with some serious leverage. However, wide stops would be necessary, and that means more risk.
  2. Buy the ETF. CurrencyShares British Pound Ster. Trst (FXB). Tracks the price of the pound very well, but does have some liquidity issues, especially in the options. This is also the most capital intensive way to trade the pound.
  3. British Pound futures and options on futures. Tracks the price extremely well and is much more liquid than the ETF. Options also give a trader the best opportunity to set up a good risk vs. reward trade.

With the at-the-money straddle in April implying an upward move of around .027, we have an upside target of 1.5412 by April expiration. Now that we have a target, we can look at a trade that gives a great reward potential with minimal risk.

Trade:
Buying the 6B Apr 1.53-1.54 Call Spread for .0025.
Risk: $156.25 per 1 lot
Reward: $468.75
Breakeven: 1.5325

This trade sets up for a 3-to-1 return on risk if the British Pound futures close above 1.54 on April expiration. A risk vs. reward ratio that spot currency and ETFs cannot offer.

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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