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In association with

Market Update 8th April 2010

The UK elections and volatility


With volatility across all asset classes globally at or near recent lows the question is: where is
volatility going now? Normally, an options trader uses low volatility to build up long positions (
going ‘long premium’) in the options market as increasing volatility drags up option prices.
However, since the start of 2010 options traders who have used any sell-off in volatility to buy
options have lost out in most cases as volatility has just fallen further.

With this week’s announcement that the UK general election will take place on 6th May, I would
like to take a closer look as to what might be the consequences of the markets of various
situations and outcomes on volatility and therefore on option prices.

To start off, I have included three diagrams of historical implied volatility on both the FTSE100,
the 10 – Year Gilt future and historical 30 day volatility for the GBP/USD exchange rate. In all
cases it is clear that volatility has fallen quite significantly and remains historically low. Although
GBP/USD has risen in recent times, it is still low in the historical context.
FTSE100 - Historical Implied Vol
55

50

45

V 40
o
l
a 35
t
i
l 30
i
t
y 25

20

15

10
01/12/2008
15/12/2008
29/12/2008
12/01/2009
26/01/2009
09/02/2009
23/02/2009
09/03/2009
23/03/2009
06/04/2009
20/04/2009
04/05/2009
18/05/2009
01/06/2009
15/06/2009
29/06/2009
13/07/2009
27/07/2009
10/08/2009
24/08/2009
07/09/2009
21/09/2009
05/10/2009
19/10/2009
02/11/2009
16/11/2009
30/11/2009
14/12/2009
28/12/2009
11/01/2010
25/01/2010
08/02/2010
22/02/2010
08/03/2010
22/03/2010
05/04/2010

Source
- Bloomberg

SEVEN DAYS AHEAD Professional trading guides and recommendations for the World's markets

Authorised and Regulated by the FSA 124 REGENTS PARK ROADLONDON NW18XL TEL +44 (0) 7849 933573
E-MAIL MSTURDY@SEVENDAYSAHEAD.COM WWW.SEVENDAYSAHEAD.COM
This information memorandum has been prepared solely for informational purposes for customers of Seven Days Ahead and is based on publicly available information from sources
believed to be reliable. It is not an offer, recommendation or solicitation to buy or sell, nor is it an official confirmation of terms. No representation is made as to the completeness or
accuracy of any statements or forecasts contained herein and no responsibility or liability is accepted for losses arising from transactions undertaken or investments purchased, sold or
held on its recommendation. Consequently, any persons acting on information contained herein do so entirely at their own risk. Although the opinions contained herein were
considered valid at the time of release, financial markets are subject to rapid and unexpected movements. Seven Days Ahead, its associated companies, their directors, employees,
other customers or connected persons may from time to time undertake transactions or deal in investments mentioned in this information memorandum or have a material interest,
relationship or arrangement in relation to them.
In association with
10 Rear Gilt - Historical Implied Vol
12

11

V 10
o
l
a
t
9
i
l
i
t
y 8

6
01/12/2008
15/12/2008
29/12/2008
12/01/2009
26/01/2009
09/02/2009
23/02/2009
09/03/2009
23/03/2009
06/04/2009
20/04/2009
04/05/2009
18/05/2009
01/06/2009
15/06/2009
29/06/2009
13/07/2009
27/07/2009
10/08/2009
24/08/2009
07/09/2009
21/09/2009
05/10/2009
19/10/2009
02/11/2009
16/11/2009
30/11/2009
14/12/2009
28/12/2009
11/01/2010
25/01/2010
08/02/2010
22/02/2010
08/03/2010
22/03/2010
05/04/2010
Source: Bloomberg

SEVEN DAYS AHEAD Professional trading guides and recommendations for the World's markets

Authorised and Regulated by the FSA 124 REGENTS PARK ROADLONDON NW18XL TEL +44 (0) 7849 933573
E-MAIL MSTURDY@SEVENDAYSAHEAD.COM WWW.SEVENDAYSAHEAD.COM
This information memorandum has been prepared solely for informational purposes for customers of Seven Days Ahead and is based on publicly available information from sources
believed to be reliable. It is not an offer, recommendation or solicitation to buy or sell, nor is it an official confirmation of terms. No representation is made as to the completeness or
accuracy of any statements or forecasts contained herein and no responsibility or liability is accepted for losses arising from transactions undertaken or investments purchased, sold or
held on its recommendation. Consequently, any persons acting on information contained herein do so entirely at their own risk. Although the opinions contained herein were
considered valid at the time of release, financial markets are subject to rapid and unexpected movements. Seven Days Ahead, its associated companies, their directors, employees,
other customers or connected persons may from time to time undertake transactions or deal in investments mentioned in this information memorandum or have a material interest,
relationship or arrangement in relation to them.
In association with
GBP/USD - Historical Vol
31

26

V
o
l 21
a
t
i
l
i 16
t
y

11

6
01/12/2008
15/12/2008
29/12/2008
12/01/2009
26/01/2009
09/02/2009
23/02/2009
09/03/2009
23/03/2009
06/04/2009
20/04/2009
04/05/2009
18/05/2009
01/06/2009
15/06/2009
29/06/2009
13/07/2009
27/07/2009
10/08/2009
24/08/2009
07/09/2009
21/09/2009
05/10/2009
19/10/2009
02/11/2009
16/11/2009
30/11/2009
14/12/2009
28/12/2009
11/01/2010
25/01/2010
08/02/2010
22/02/2010
08/03/2010
22/03/2010
05/04/2010
Source: Bloomberg

How will the UK election affect volatility among these asset classes: equity, bond and
currency?

There are two possible outcomes: one party will have a clear victory or no clear victory
leading to a hung parliament.

In the case of one party achieving a clear victory we would not expect a big move in
volatility as it will take time for the new government to formulate and introduce any new
economic policy.

However, if there is a hung parliament it is quite likely that volatility will increase quickly.
The reason for this is simply that the UK is not used to hung parliaments or coalition
governments and this will therefore increase uncertainty.

Also, volatility is quite likely to increase in the time leading up to polling day as various
different opinion polls show different outcomes. The closer the parties are tied the more the
increase can be expected.

SEVEN DAYS AHEAD Professional trading guides and recommendations for the World's markets

Authorised and Regulated by the FSA 124 REGENTS PARK ROADLONDON NW18XL TEL +44 (0) 7849 933573
E-MAIL MSTURDY@SEVENDAYSAHEAD.COM WWW.SEVENDAYSAHEAD.COM
This information memorandum has been prepared solely for informational purposes for customers of Seven Days Ahead and is based on publicly available information from sources
believed to be reliable. It is not an offer, recommendation or solicitation to buy or sell, nor is it an official confirmation of terms. No representation is made as to the completeness or
accuracy of any statements or forecasts contained herein and no responsibility or liability is accepted for losses arising from transactions undertaken or investments purchased, sold or
held on its recommendation. Consequently, any persons acting on information contained herein do so entirely at their own risk. Although the opinions contained herein were
considered valid at the time of release, financial markets are subject to rapid and unexpected movements. Seven Days Ahead, its associated companies, their directors, employees,
other customers or connected persons may from time to time undertake transactions or deal in investments mentioned in this information memorandum or have a material interest,
relationship or arrangement in relation to them.
In association with
However, as we all know the only true and real opinion poll is the actual vote. Therefore,
we can turn to the old saying “buy the rumour and sell the fact”. This implies it may well
make sense to buy options at this early stage of the campaign and then sell the options
when the result comes in at which stage the market will probably start discounting the
reality of the new government however, it may turn out to be and UK markets will return to
normal.

In the coming days Seven Days Ahead will looking for any opportunities to use to go long
volatility in the UK market.

Of the three asset classes we prefer the Gilt market. The reason why the Gilt market will
most likely see the biggest move is two-fold.

Firstly currently bonds are already at high levels in terms of price (low yields) therefore a
sell off is quite possible.
Secondly, no matter what type of government takes over after the election, one of their
biggest priorities is going to have to be tackling the public deficit. This may well add further
to Gilt issuance which will have the affect of forcing yields higher (prices lower) over time.
This therefore makes

Gilts are a good candidate for a long options strategy.

The main reason why we choose not to focus on the FTSE in the current environment is
the fact that the FTSE is an extremely internationally-focused equity index. If we look at
some of the largest holdings in the index such as Shell, BP, Rio Tinto and BHP for example
they all have very little to do with the domestic UK economy.

Mark Ridgeway
Seven Days Ahead

SEVEN DAYS AHEAD Professional trading guides and recommendations for the World's markets

Authorised and Regulated by the FSA 124 REGENTS PARK ROADLONDON NW18XL TEL +44 (0) 7849 933573
E-MAIL MSTURDY@SEVENDAYSAHEAD.COM WWW.SEVENDAYSAHEAD.COM
This information memorandum has been prepared solely for informational purposes for customers of Seven Days Ahead and is based on publicly available information from sources
believed to be reliable. It is not an offer, recommendation or solicitation to buy or sell, nor is it an official confirmation of terms. No representation is made as to the completeness or
accuracy of any statements or forecasts contained herein and no responsibility or liability is accepted for losses arising from transactions undertaken or investments purchased, sold or
held on its recommendation. Consequently, any persons acting on information contained herein do so entirely at their own risk. Although the opinions contained herein were
considered valid at the time of release, financial markets are subject to rapid and unexpected movements. Seven Days Ahead, its associated companies, their directors, employees,
other customers or connected persons may from time to time undertake transactions or deal in investments mentioned in this information memorandum or have a material interest,
relationship or arrangement in relation to them.

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