By Ted Howard
Scottish Independence is making hedging the pound expensive. A powerful yen almost 20 years ago created similar challenges.
Just a few weeks ago Scottish Independence seemed like a distant possibility that people mostly chuckled about. But as the vote gets nearer, the possibility of a Yes vote has risen dramatically. The 307-year-old union appears closer to over than ever.
According to reports, the tightening in opinion polls has come on the heels of a televised debate in which Alex Salmond, Scotland’s first minister and leading Yes (or Aye) man, was seen to have outmatched the leader of the No campaign, British Labour Party’s Alistair Darling. And just like that, the Yes vote odds went from 15/2 to 3/1 in the past seven days, according to the Betfair Exchange.
And just as suddenly, it’s getting expensive to buy protection against big swings in the pound around the voting date, September 18, as companies and speculators look to hedge their risks. But history shows that they should consider spending the money.
the yen example
US multinationals faced some of the same challenges back in the mid-90s, particularly as the yen soared and dollar tanked and tanked… and tanked again. In 1995, companies were in a position where they were trying to protect themselves against the swings (mainly downward) of the dollar.
According to an analyst quoted in “A Yen for More?” published in International Treasurer May 1, 1995, many companies did not do as well as they could have in 1994 because “they kept trying to pick the bottom of the dollar. But companies that bought options and left their yen positions on did rather well.”
Unfortunately by the time the dollar bottom pickers figured it all out, options were expensive to put on, much like today’s prospective sterling options buyers. In 1995, treasurers were instructed to wait for the markets to quiet and then to “look for opportunities to buy slightly out-of-the-money options with strikes set for the dollar to rise, purchasing progressively more out-of-the money options to cover anticipated transactions further out in the future.”
But waiting wasn’t necessarily right for everyone because it could get more costly to do so.
“Not all companies would necessarily wait for low volatility periods, and hence cheaper option premiums,” International Treasurer quoted a treasurer saying at the time. He pointed out that it had been a very long time since his company had seen single-digit volatility in 12-month options. Further, he said, “given the size of our business in Japan, and two- to three-yen moves intraday, the potential financial impact of an adverse yen-dollar move significantly outweighs the costs of paying up for volatility.”
Slim just left the building… temporarily?
So what to do in the United Kingdom? Obviously it depends on the amount of business done there. Despite the recent flurry of Yes-biased activity, odds-makers still say ultimately, Scottish voters will vote to stay. Still, what may be more of a concern are those companies banking with Scottish financial firms. Royal Bank of Scotland, according to the Bank of England governorMark Carney, might have to relocate if Scotland voted for independence. And some banks, like Lloyds, have lost billions in value after their shares tanked amid the concerns.
Although likely not market-rattling in the way the threats of a eurozone breakup distressed markets back in 2011 and 2012, Scottish independence could bring back some of that ambiguity —and create big winners and losers in the options market.