While U.K. equity investors have kept their calm ahead of Thursday’s general election, they’re not leaving anything to chance.
With polls in recent days showing a tightening race between Prime Minister Theresa May’s Conservative Party and Jeremy Corbyn’s Labour, traders have boosted hedging, sending the number of FTSE 100 Index options to this year’s high. Even as the gauge sits near a record, a measure tracking the cost of contracts protecting against swings is hovering around a two-year high relative to implied volatility for the regional Euro Stoxx 50 Index.
“We are seeing the natural, sensible hedging that usually precedes risk events like a general election,” said Ken Odeluga, a market analyst at City Index in London who also covers derivatives. “Some investors are seeking protection as a Conservative majority, while still likely, is looking less like a done deal.”
A ramp-up in equity turbulence is common ahead of a risk event as investors increase hedging before unwinding their bets later. After surging before the referendum on European Union membership last year, the FTSE 100’s implied volatility erased its gain in a couple of weeks. It took about as long for it to fall to an almost three-month low following the 2015 general election.
And while one-month implied volatility on the British index has climbed only 5 percent in the past week, that compares with almost no change in the measure for the Euro Stoxx 50. The number of outstanding options on the FTSE 100 has risen 20 percent since the April expiration to 2.9 million, while the open interest on one-month futures has reached a record.
U.K. stocks remain supported by strong profit estimates and attractive valuations, Odeluga said. He is echoing strategists at JPMorgan Chase & Co. and Deutsche Bank AG, who see further gains for the country’s equities, relative to European peers. Gauges of British large-, mid- and small-cap stocks are all trading near records.
Analysts project profit growth of 35 percent at FTSE 100 companies in 2017, versus 11 percent for Euro Stoxx 50 constituents. The U.K. benchmark, whose members get about three-quarters of their sales overseas, is trading near its cheapest level since 2014 relative to the broader gauge, on an estimated price-to-earnings basis.
Equity investors are also keeping their eyes on the pound, for which short-term volatility has jumped. The currency is a big factor in determining the fortunes of the nation’s shares, with even domestically focused companies included in the FTSE 250 Index getting a large portion of their revenue from abroad.
For now, the market is implying a one-day move of 1.3 percent in the FTSE 100 after Thursday’s election, JPMorgan strategists wrote in a note this week. That would be less than the fluctuations following the last two general elections. The firm recommended an options strategy on Europe’s stock-volatility index.
“We could see a spike in volatility in the next couple of days,” London-based CMC Markets analyst David Madden wrote in a note Wednesday. “The pro-business policies of the Conservative Party would be favored by the financial markets, but the dwindling lead they have in the polls over the Labour Party is causing some concern.”
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