Sterling traders are ready for another 8% drop after the market decline

(Bloomberg) — Options traders are bracing for the pound to fall as much as 8% more, as financial woes that led to a painful selloff in U.K. markets last week weigh on the currency.

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There is huge demand for contracts paying less than $1.20 — roughly 2% below where the currency traded on Friday — according to data from the Depository Trust & Clearing Corporation. Some traders are even betting that the British pound will fall below $1.12, the weakest level in more than two years.

The pound proved to be the most fragile currency among its developed country counterparts last week, as concerns over Donald Trump’s policies, persistent inflation and high borrowing levels led to a global decline – with UK assets at the center of the turmoil. Investors say the market is underestimating the need to cut interest rates to stimulate the economy, another source of potential pressure on the pound.

“The path of least resistance is the lowest at this point,” said Jamie Niven, fund manager at Candriam. “On the one hand, you have very limited pricing in on the Bank of England’s cuts, while financial concerns are also negative for sterling.”

Sterling fell alongside other British assets last week, as 10- and 30-year government bond yields jumped by a quarter of a percentage point and the FTSE 250 stock index posted its worst fall since mid-2023. That prompted comparisons with the post-Budget market crash. Liz Truss’ disastrous mini in 2022, though the intensity of the moves wasn’t identical.

However, demand for pound options last week surpassed levels seen during that crisis – and even around the 2016 Brexit referendum.

According to Mimi Rushton, global head of currency distribution at Barclays, there has been a 300% increase in trade inquiries related to sterling options, with hedge funds flocking to bet on further weakness. The unusually high volumes made some trading conditions “more difficult,” she said.

Contracts on the pound, which would be paid if it strengthened against the dollar, were favored at the start of the year. But the rise in bond yields seen last week led to the biggest shift in sentiment in more than two years, DTCC data show.

Tim Brooks, head of FX options trading at Optiver, said demand for “longer-dated options remains very high, suggesting that the market is not yet over this issue.”

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