Societe Generale Sees Pound Weakening, Recommends EUR/GBP Strategies

France's Societe Generale has identified the British pound as the most vulnerable currency in Europe, recommending three options strategies to go long on the euro/pound (EUR/GBP) pair. The bank's in-depth analysis of the pound highlights several unfavorable factors that are expected to further weaken the currency. The UK is facing an unfavorable combination of fiscal and monetary policies, with a budget expected to tighten further in November, followed by a rate cut. The government aims to control spending to establish fiscal credibility, but actual implementation is challenging, making tax increases inevitable.

High inflation has slowed the pace of rate cuts by the Bank of England, with its rate cycle only 50%-60% complete, compared to the European Central Bank, which has completed 80%-90% of its easing cycle. Market expectations for a rate cut by the Bank of England in November are close to 50%. In terms of exchange rates, the euro is expected to rise to 1.25 against the dollar next year, while the pound is seen as the weakest European currency. The EUR/GBP exchange rate is expected to gradually rise to 0.90, with the current rate consistent with its short-term interest rate differential, indicating an imbalance that is likely to result in a rise.

On the trading strategy front, Societe Generale suggests leveraging structural opportunities in the options market. Given the high level of bullish skew in EUR/GBP, the options market maintains bullish expectations through top premiums, allowing for low-cost strategies to achieve positive theta returns and protect at-market-priced positions.

The specific strategies recommended include: buying a 3-month EUR/GBP call spread 1x2 (strike prices 0.8720/0.8860, zero cost), with a top breakeven point at 0.90; buying a 2-month EUR/GBP call option (strike price 0.88, knock-out price 0.9050, indicative quote 0.16%); and buying a 3-month digital call option on EUR/GBP (strike price 0.90, indicative quote 12.5%).

In terms of holding positions, the first two strategies are recommended to be held until expiration, while the digital call option can be closed early if the appreciation slows down to recover time value. It is important to note that if EUR/GBP rises rapidly, the call spread strategy may require spot delta hedging to manage short gamma risk.

In terms of risk warnings, investors buying call spreads face unlimited risk if EUR/GBP exceeds 0.90, as the nominal amount of the short strike price is higher than that of the long strike price; the knock-out call option will expire if EUR/GBP reaches 0.9050; and the risk of the digital call option is limited to the initial premium. Additionally, rapid spot appreciation may result in gamma risk, requiring hedging measures.