This coming Thursday, June 23, 2016, the “brexit” vote will be held in Great Britain. Voters will be deciding whether to remain or leave the European Union. This is a classic binary event and like an earnings announcement, Implied Volatility (IV) is elevated and the front month volatility is the highest (usually back months are higher). How can we best trade this and other binary events?
There are futures contract on both the Euro (/6E) and British Pound (/6B) plus mini contracts on both (/M6E and /M6B). There are ETFs for both the Euro (FXE) and the Pound (FXB) but the ETF for the Pound has serious liquidity issues and should be avoided. The markets as of this past Friday were expecting a large move in the British Pound with the 5 day projected range (derived from the IV of the options) was + or - $4820 and the 30 day range was + or - $7000. The mini contract is 1/10 of that. Predictit.org, a legal wagering web site had been placing the chance of a Brexit at 45% last week but it is down to 28% today. Both the Euro and Pound increased but the Pound increased much more. Despite that the Euro is still up around 3% for the last 6 months while the Pound is down 3%.
One possible trade idea is to do a Pairs Trade going long the Pound and short the Euro, looking for them to reverse some of their moves over the last 6 months. Because of the size of the contracts and the amount they move we would go long to Pound contracts for each short Euro. We can use the mini contracts if this is too capital intensive. Another possibility is to use options in either the /6E or FXE. There are no options in the mini futures and the Pound futures and ETF have liquidity issues. We can setup the pairs trade version of a Covered Call by buying the /6B and selling calls in either /6E or FXE against it. This should require less margin than the outright pairs trade. Some market “experts” were advising to buy options ahead of the Brexit vote and then sell on the close Wednesday ahead of it. The problem with that, as Tom and Tony pointed out, is that if the odds change a few days before the vote the strategy doesn’t work. This is what happened today. We need to look for opportunities to short option premium when trading a binary event and never initiate a long position.
Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the valuable takeaways and a better understanding of binary events, especially the Brexit vote, and how to trade them.
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