All eyes over the past few weeks have been on the British pound. The currency has been on a wild ride, hitting as low as $1.03 against the dollar before recovering, currently trading at $1.11.
The violent moves came as newly appointed Prime Minister Liz Truss made her mark proposing giant tax cuts (which primarily benefited the rich) before making a humiliating U-turn on an outcry from economists and the public alike.
With British pound volatility elevated at near historic levels, investors can sell a straddle on the Invesco Currency British Pound ETF.
Trade Takes Advantage Of High Volatility In British Pound
A short straddle is an options strategy where an investor takes no view of the up or down direction of shares on inception. Instead, the trader believes shares will move less either way than the market is anticipating.
With FXB ETF trading around 107 a share Friday, investors can consider placing a short straddle by selling the 107 call and 107 put on the March 17 expiry. This trade can be placed for a credit of $9.20 per share, which also coincides with the maximum gain of $920 if the shares trade at 107 on expiration.
An investor will earn a smaller profit if FXB is trading between 97.8 and 116.2 on expiration.
Elevated Levels of Volatility, What History Tells Us
The March options on FXB have an implied volatility of 16%. This is nearing historically high levels. Over the last 10 years, there have only been two occasions where FXB has realized more than 16% volatility over a 30-day period. This came during Brexit and the breakout of the Covid pandemic, when volatility peaks of 29% and 19% were realized, respectively.
In the past, these strong moves of volatility have calmed down quickly. The 150-day realized volatility (similar to the length of these options) has never reached above 16% over the past 10 years. Currencies generally have muted moves. An average year of volatility on FXB can see volatility of around 8%.
Of course, this is not an average year. With a jumpy Truss and vast disagreements on a path forward, volatility of the British pound will be high. Nevertheless, a prolonged period of historic volatility in the currency would need to occur for these options to be cheap.
In the event of this happening, and because a short straddle has unlimited downside risk, investors should close the position at no more than two times the initial credit on the position.
