Scotland Will Vote NO: Go Long GBP/USD And Sell GBP/USD Volatility

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Includes: FXB, UUP
by: Valtteri Ahti

Summary

Scotland is highly unlikely to exit its Union with the rest of the UK. Bookies assign a 25% chance that the Scots vote “yes” on Thursday the 18th.

The pound sterling has reacted strongly to the tail scenario of Scottish devolution. Bond markets have been characteristically blaze.

One wishing to capitalize on the "kilt" premium should go long GBP/USD and/or go short GBP/USD volatility.

Historians have viewed Scotland as a distinct entity since its primordial inception as the Kingdom of Alba that ruled the lands from 900 to 1286. Alba united a hodgepodge of peoples and the next 700 years saw a common identity evolve. Scots might feel less Scottish had William Wallace and Robert the Bruce not prevailed against the English in the Battle of Bannockburn in 1314.

Alas, union with England had to wait another 400 years until 1707. The English applied increasing pressure for union and the pragmatic Scots realized their exports would be blocked from the English market and from its burgeoning empire lest they give in. Having taken the proverbial plunge the Scots to their credit embraced union wholeheartedly and contributed - especially in terms of manning the civil service across the British empire - perhaps more than any other part of the realm.

The 300 year old Union has been roaring a success for both parties. One could make the case that there was a point when Scotland would have been better off going it alone. The discovery of a North Sea hydrocarbon bonanza in the late 1960's and 1970's should have signaled Scottish independence. The Scottish currency would be a petrocurrency, but that hasn't stopped Norway (with a population of just 200K less than Scotland) from becoming the richest country in the world if one excludes distasteful states in Europe that owe their riches to tax laundering services.

The Scots missed the devolution train. Leaving now would involve terrible economic costs. Firstly, North Sea oil revenues have begun to decline. Secondly, Scottish demographics are worse than English. In a very real sense the aging Scots will be able to freeload on a younger English nation. Thirdly, an independent Scotland would have to pay a premium on its sovereign debt over the UK.

The Scots are as pragmatic about economics now as they were 300 years ago. Tis the land of Adam Smith lest ye forget. Forget the shoddy polling numbers, a more accurate estimate of devolution is provided by the bookies that place the odds of secession at 25%. The Scots should prove as pragmatic as they did 300 years ago.

The best way to play the Scottish vote is via the FX market where the pound has overreacted against the dollar (see chart). In the medium term the pound is taking a beating against the dollar. This is more reflective of the dollar's surge against all currencies rather than of British weakness. In fact the UK economy is ahead of the US in terms of the business cycle, which in turn is front running the euro area economy. In the long run (2-4 years) it hence makes sense to be long both the dollar and the pound against the euro as monetary policy and economies continue to diverge. However, before the election results on Friday it makes sense to tactically capitalize on nervousness concerning the referendum by going long the pound against the dollar due to the recent drop. An even better way to trade nervousness is to go short pound volatility through the options market (sell GBP/USD options). After the dust settles - presumably next week - it is best to return to long dollar positions and/or neutralize volatility positions.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.