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Trade ahead of Brexit with upside calls

brexit.jpg

 

BY: NICK PIQUARD, CFA®, VICE PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS

The Brexit vote is almost upon us and there is no shortage of opinions on both sides. However, one thing is certain: no matter which camp wins, there will be volatility in the market. Much of the market uncertainty due to the Brexit vote has been manifesting in a rush to safe-haven assets: gold, U.S. treasury bonds and put options. Various surveys are showing the “leave” and the “remain” votes are neck-and-neck.

So what position should investors consider? As has been apparent from the wild fluctuations, the stock market will likely suffer in the event of a vote to leave. The months and years of uncertainty could initially weigh heavily on the British economy, but may also impact the rest of the world too, — given the large size of Britain’s trade and GDP.

Options traders are sophisticated and given the asymmetric risks involved with Brexit, they have accordingly placed an expensive price on put options. The volatility skew as measured by the Nations SkewDex is at a 1-year high, meaning that buying downside protection for a portfolio has become very popular ahead of the vote. All hope is not lost however, as an elevated skew also implies that out-of-the-money calls are relatively cheap.

My feeling is there is a lot of money waiting on the sidelines waiting for the outcome of the vote. If the British vote is to remain in the Eurozone, there will very likely be a big relief rally in shares and the inexpensive call options will benefit. Ahead of the Brexit vote, consider reducing equity exposure and buying upside calls, instead of looking at buying expensive downside puts.

The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

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