Trading the Brexit vote

UK stocks have so far showed little reaction to the impending UK referendum on EU membership, but that’s likely to change as the vote nears. There are ways investors can look to trade the volatility around the vote and the result itself.

Woman walking past Westminister
Source: Bloomberg

Markets hate uncertainty, and the UK’s referendum on whether to remain in the EU is raising plenty of that. As the June 23 vote nears, and markets focus on the potential outcome, volatility in the London stock markets is likely to increase, opening up opportunities for investors looking to trade on the outcome.

The Brexit vote is a rare event with few precedents. The most recent was the Scottish referendum on whether to remain part of the United Kingdom. In the months leading up to that vote in 2014, markets displayed significant complacency, with most investors expecting the vote to go the way of the pro-Union camp. In the end it did, but there was sudden panic in the markets in the final weeks, when a solitary poll put the pro-independence camp in the lead. Sterling fell and stocks of companies with strong links to Scotland came under pressure. 

The Brexit referendum may play out in the same way. The majority of polls currently point to a victory for the ‘Remainers’, although current voting intentions are closer than the campaign to stay would like to see. IG clients are currently more convinced the UK electorate will vote to stay in the EU – they think there’s a 65.5% chance of that happening according to IG’s EU Referendum Barometer.

If a trader thinks the UK will remain in the EU, then the lead-up to the vote, and the likely increased volatility, is a chance to buy weakness in UK indices, stocks or sterling, in the belief the actual vote will be in line with what most polls and the UK will remain within the EU.

A second way to trade the vote would be on the ratio between a UK-focussed ETF and one that tracks European stocks, such as the EuroStoxx 50. For example the iShares MSCI UCITS ETF and the iShares EuroStoxx 50 ETF. The chart below shows the ratio has been trading in a range since the first quarter of 2014. A move to the top end of the range (towards 0.50) would suggest a trade that shorts the UK ETF and buys the Europe ETF, while a drop to the bottom (circa 0.46) would indicate that the converse would apply  - sell Europe and buy the UK:

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