On June 23, Great Britain’s voters will decide in a referendum on the question: “Should the United Kingdom remain a member of the European Union (EU) or leave it?”
The EU, which consists of 28 countries, has the critical structural advantage of allowing for free movement of people between the different countries and in particular, between the EU and Britain. A vote for exit will generate great uncertainty about the impact on the British economy as business transactions with the EU, a major UK trading partner, will require new deals and terms. It will be a key factor in the fate of about two million European nationals who now work in Britain and have certain benefit rights while working there.
We do not know what will be the outcome of the Brexit vote; however, we do know that there will be increased anxiety and volatility leading up to this vote. This anxiety has already translated into pound weakness in the spot market. In the options market the one- and three-month volatility smiles are skewed to the put side. Even British corporate bonds are feeling the heat as the market assesses greater risks to those pound based corporate notes in the light of a possible yes vote. All this points to a major opportunity in trading the British pound. Let’s take a closer technical look.
From a multi-time frame perspective the GBP/USD price action provides a rare trading opportunity. The GBP/USD has reached lows not seen since March 2009. The GBP/USD priced near the 1.4265 (as of March 16) is 1690 pips from the highs of June 30, 2015. The potential of a 1000-pip gain in the GBP/USD, if Britain remains in the EU is possible. The challenge in the next two months is how can a forex trader approach the Brexit vote? Let’s look at some scenarios.
One of the most interesting approaches will be to trade the GBP/CHF cross pair. The Swiss Franc acts as a safe-haven and in the case of a vote to leave the EU, is likely to strengthen against the GBP. Of course, the opposite is true and a look at long-term support and resistance in the GBP/CHF shows a reward-to risk ratio of 3: 1 in either direction (see “Breaking out”). Let’s take a closer look.
Those who want to bet on a Brexit would sell GBP/CHF. A downside breakout level would be triggered with a break of recent support at 1.3830. A 100-pip protective stop would provide a cushion for volatility with profit target of 1.3599. A retracement to the 1.3016 lows of Jan.16, 2105 is not impossible.
Those who want to bet on the UK remaining in the EU could buy the GBP/CHF. As the vote gets closer, watching price action for entry points will be necessary, but the overall strategy would be to buy when the GBP/CHF sets new highs. A buy entry at 1.4268, the February high, would provide a strong signal of a bullish reversal. Once again, a 100-pip stop would be reasonable as we are looking for a 300-point+ profit target. The GBP/CHF has been in a range of 1.5485 to 1.3814 so these breakout opportunities are strong.
Perhaps a better strategy here would be to execute a long strangle or straddle that would benefit from a spike in volatility. It is a great strategy to utilize before a closely contested election where each outcome is expected to create a significant move in opposite directions. As the vote gets closer it will be a good idea to monitor the odds given by the famous London bookies on the outcome. A clear favorite may emerge and, typically, odds based on people placing real bets are more accurate than the analysis you will get from so-called experts in the financial media.