Capitalizing on bearish British pound expectations

Wednesday saw Mark Carney, governor of the Bank of England, give his first speech since joining the BoE on the future of monetary policy. In August the central bank pledged to keep rates low until a predetermined unemployment level of 7% was hit. While BoE officials believe it will take until at least 2016 for this to happen, the markets are speculating on a rise in rates much sooner than that. In his speech Carney stressed that the Monetary Policy Committee will not allow rising rates to threaten growth in the economy and will be ready to provide stimulus if this should happen. While Carney did not specifically say what these stimulus measures would look like, they would most likely be outright asset purchases or an even deeper cut of interest rates.

British pound futures (CME:B6Z13) reacted to Carney’s speech by ending the day lower, and continuing to sell off. While Carney’s speech may not have included the guidance the market was looking for, it did make it very clear that Carney and the BoE will not risk derailing an already fragile recovery in their economy. This means that rates will stay low for the foreseeable future and that further easing is definitely a possibility in the U.K.

So how can a trader take advantage of possible downside in the British pound?

  1. Trading the spot pair. This is the most direct way to take a speculative view on the pound, but can be capital intensive and would require a trader to take on a lot of risk when taking a medium-  to long-term view.
  2. Trade the ETF. The CurrencyShares British Pound Sterling Trust (FXB) tracks the price of the pound very well, but is the most capital intensive way to trade the pound. The risk required to take a long-term trade is also high.
  3. British pound futures and options on futures. Provides leverage while still allowing a trader to set up a well-defined risk vs. reward setup.

With the November at-the-money straddle in October implying a move of 0.045 by expiration we can set up a trade at defined targets. We can calculate a downside target of 1.505 and use this target to center a trade.

Trade: Buying the Oct 1.52-1.50 Put Spread for 0.0045
Risk: $281.25
Reward: $968.75
Breakeven: 1.5155

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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