The cost of hedging against near-term swings in the British pound jumped to four-year highs on Friday and investors added to unfavourable bets in the derivatives market, reflecting jitters about the result of the Scottish referendum. One-week sterling/dollar implied volatility rose to a peak of 15.525 percent, according to Reuters data, its highest since mid-2010. The one-week options will expire on September 19, the day after Scotland's vote on independence from the United Kingdom, when the results should be announced.
In the derivatives market, the one-week and one-month sterling/dollar risk reversals, a gauge of demand for options on a currency rising or falling, showed an increasing bias for sterling weakness. In the spot market, sterling slipped to $1.6221, failing to build on earlier gains in Asia but still above the 10-month low of $1.6051 struck on Wednesday. It hit a high of $1.6277 in Asian trading after a YouGov survey showed those in Scotland who intended to vote against independence were gaining the upper hand.
The euro rose against the pound to 79.68 pence, on track for second week of gains. Sterling's dip came despite another poll, the Guardian/ICM poll, showing support for the union at 51 percent and nationalists on 49 percent, with "don't knows" excluded. Traders said investors were staying away from the pound before the weekend given all the risk involved.
"A `Yes' vote would be a game-changer. The uncertainty and what it would mean for UK monetary policy would easily justify sterling/dollar trading close to $1.50," said Chris Turner, head of currency strategy at ING. Sterling is a prominent part of the debate over Scotland. The pro-independence leader, Scottish First Minister Alex Salmond, says Scotland will share the pound. Westminster has ruled that out, leading to uncertainty about how debt, North Sea oil revenues and the currency will be shared.
Investors fear that a Scottish split would leave Britain saddled with higher debt, a wider current account deficit and a smaller domestic market that could hurt future investments. More debt could also lead to a possible downgrade by rating agencies and outflows from Britain.
Investors pulled $27 billion out of UK financial assets last month - the biggest outflow since the Lehman crisis in 2008 - data compiled by London-based consultancy CrossBorder Capital showed, as worries about Scotland hit home. Traders expect more swings in the pound as more polls are released in the days before a vote that is too close to call. Morgan Stanley said in a note that its daily flow data indicated significant outflows from UK stocks going into last weekend, mainly because of the Scottish referendum and investor concerns that a "Yes" vote would hurt growth prospects.
The referendum jitters come after a rough couple of months for the pound, which is now around 10 cents lower against the dollar since its high of $1.7192 struck in mid-July. Having ignored the risks from a "Yes" vote until late August, investors, including hedge funds, are now making a beeline to buy protection against sharp fluctuations and further downside in the pound, traders said. The one-month implied volatility for sterling/dollar was elevated, having hit a three-year high of 11 percent earlier this week. On Friday, it was at around 9.2 percent, still higher than two-month implied vols, which were trading at 8 percent.
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