Trading strategies to profit from a Brexit

Apart from forex markets, bond markets will see volatility because treasury yields in the pound sterling will be volatile.

Forex markets will be focussed on the possibility of the Brexit through most of June. The referendum itself is on June 23 but there is already a build up of anxiety about the possibility of the UK pulling out of the common market of the European Union (EU).  

We can worry about the long-term effects of a Brexit if it does occur. What is guaranteed is some short-term turmoil. Since Britain has continued to use its own currency, the pound sterling (GBP), which is of course, fully convertible, there will be a focus on the GBP. That will mean volatility for all sorts of paired currency contracts, including the liquid GBP-INR and the very liquid GBP-Euro and the GBP-USD.

Apart from forex markets, bond markets will see volatility because treasury yields in GBP will be volatile. Changes in those yields will lead to traders looking at plays in other bonds. Finally, there will be some sort of impact on stockmarkets.

At one level, this is a binary decision. The UK will either vote to stay in the EU, or it will leave. Regardless, the EU will remain not only the largest economic block in the world; it will also remain stressed by a combination of slow growth, near-deflation, an unending refugee crisis, the poor demographics of ageing populations, etc.

If Britain stays in, there will be sighs of relief and the EU will be back to business as usual. If Britain does exit, there will need to be a review of trade agreements between the UK and the EU. As of now, goods and labour travel without hindrance between the UK and the Euro-denominated EU. What sort of reworking will arise with a Brexit? Will the UK raise tariff barriers and vice-versa?

Most observers believe that a Brexit would mean lower trade between the EU and Britain, which would hurt all concerned. If a Brexit does occur, it would almost certainly lead to political upheaval in the UK, and the government may fall. If there's a Brexit, it will encourage other European nations with strong anti-EU lobbies to consider getting out of the currency union.

But those are all contingent worries. In the immediate future of the next three-four weeks, we will probably see pressure on the GBP with large amounts deployed to short the sterling. That pressure could intensify if there is news-flow suggesting that the Brexit is likely. The GBP could also take an extra hammering if the US Federal Open Markets Committee is hawkish at its meeting in mid-month. The USD would appreciate strongly if there are fears of an immediate USD rate hike and the pound would be most likely to take a beating.

Apart from currency, there will be volatility in stock markets. Every European bourse is likely to see some selling until such time as the referendum is completed. Of course, if Britain decides to stay with the EU, there will be a relief rally with stronger GBP and upside to European equities.

It is possible, perhaps even likely that the Brexit newsflow will infect Indian and other EM assets. This sort of event tends to lead to "risk-off" behaviour. It is quite likely that FIIs will move out of EM assets and probably head for the safety of US treasuries or perhaps, eye Yen-denominated assets. Traders in India should stay braced for chances to play both sides on the GBP-INR contracts and to exploit a possible correction in equities. There could be a chance to go long on the GBP-INR contract before the referendum and to reverse the position and short the GBP-INR contract afterwards if Britain votes to stay in.

That way, the trader could win if the GBP first falls and then recovers.

source : BS