In early May, the UK held regional elections. The charts above show the results per the BBC in England, Scotland and Wales. The major takeaway is that the governing Labour Party did not do as well as it expected to do. In England and Wales in particular, the Reform UK Party did much better than Labour. This could lead the market to anticipate that it will be difficult for the PM and his administration to maintain fiscal discipline as non-majority governments have shown that there needs to be more spending in order to get enough votes to have things get through Parliament. 

The table above from The Telegraph shows the projected number of members of Parliament for each party in the UK. As you can see, the Reform UK Party clearly has the most seats but does not have a majority indicating that it would need to find partners to form a majority. The prime minister does not need to call for a general election until 2029 given he just took power in 2024. However, if there is a loss of confidence in his party, he may choose to call an early election. Given the poor showing in these local elections, that may be unlikely which could lead to the potential for a lame duck prime minister and governing majority. This could lead to the market losing confidence in the UK and UK asset markets. What could that mean for the British pound?

The relative strength of the UK economy versus the U.S. economy has been a reasonably good signal for the direction of the British Pound futures. The chart above shows the ratio of the UK Purchasing Managers Index to the U.S. PMI (in white). Comparing this to the generic front-month British Pound futures shows good co-movement over the last several years. The pound had anticipated relative strength starting in 2025, and it took several months for that to materialize. As a result, the pound went sideways for much of 2025. Over the last few months, the UK economy has begun to deteriorate, not so much on an absolute basis, but relative to the U.S. economy. Could this point to weakness in the British pound from here?

The old market maxim is that capital flows to where it is treated the best. To gain an understanding for whether capital will flow into or out of the UK compared to the U.S., one should look at the relative performance of UK asset markets. The top chart shows the relative performance of the UK FTSE stock index versus the U.S. S&P 500 stock index. This ratio leads the British Pound futures by 1 year. One can see that over the last 2 years, the UK stock index has consistently lagged the U.S. stock index. Thus, equity investors are getting worse returns on a relative basis being invested in the UK. This has led to weakness in the pound in the past, though currently, the pound has shown more strength that one might expect. The same is true if you look at government bond markets. The bottom chart shows the relative yields of UK government bonds (10-year Gilts) vs. U.S. government bonds (10-year Treasuries). This is another ratio that has historically led the performance of British Pound futures by a year. It is another potential indication of downside in British Pound futures. 

Turning to technical analysis, I can start with the daily Ichimoku chart for the generic front-month British Pound futures in the top chart. I see that futures had moved above the cloud and were pointing higher to start the year. Over the last month, post the UK local elections, prices have broken below the Ichimoku cloud. Not only that, but the lagging span has now also broken below the cloud, indicating a change in trend to lower prices. Given the RSI is not showing signs of being oversold and the MACD is starting to point lower, there are clear downside pressures building for British Pound futures. The daily candle chart below also gives some negative signs. Generic front-month futures have moved below the 1-, 3- and 12-month futures. In addition, the 3-month futures contract has moved below the 12-month futures contract, pointing to downside pressure. Overlaying the Fibonacci retracement lines of the move from the low in January of 2025 to the high in February of 2026, one can see the area where a simple retracement of that move, not even a major change in trend, points to. The area between 38.2% and 50% retracement of that move over a period of a year gives a price target of approximately 130 – 132 compared to the current price of 133.50. If there were a change in trend, as indicated by the Ichimoku chart, traders could see even more downside pressure build and this range might not even be bearish enough. Suffice to say, technically speaking, the charts look reasonably bearish for British Pound futures.

Now it is time to see what the options markets are saying. The top chart is the CVOL Index of implied volatility for British Pound futures. This indicates a reasonably bored, if not complacent, options market as the CVOL Index is trading near the lows traders have seen for the past 3 years. This is not what you might expect if the market was expecting a large move. Looking at the internals of the options market, one might get a different impression. The skew ratio is the ratio of upside variance to downside variance or the relative demand for calls vs. puts. The relative demand for upside vs. downside in FX is known to be volatile and move with investor views on the underlying. In the last few months, this skew ratio has fallen from about 1 (equal demand for upside vs. downside) to less than 0.9, indicating more demand for downside options than upside options. This may indicate that traders are starting to expect a move to the downside and are bidding up those options, perhaps expecting hedging demand to materialize. Overall, the price of options is not that demanding, though the relative price of downside vs. upside has gone up recently. 

Now I can look at the full implied volatility surface to see the relative pricing not only of puts vs. calls but also each of them vs. at the money. In addition, I see the relative pricing of each expiration date vs. the others as well. The first thing I notice is that pricing for out-of-the-money puts is higher than both OTM calls and ATM options. I also see that implied volatility is slightly higher for the expirations at the end of June than it is as I look into July. With no obvious catalysts on the horizon, this difference in option pricing could present an opportunity for traders that are looking for discounted options to express their view. In particular, the WG1N6 expiration may present a good opportunity because not only is the ATM option cheaper than the expirations on either side of it, the OTM put option premium is also less than the premium put options have to the ATM in other expirations. 

Putting it all together, fundamentally there may be a bearish story unfolding in the UK based on recent local election results. The ruling Labour Party had a poor showing which may lead to a lack of confidence in the current administration. That could also make it more difficult for the administration to show any progress fiscally, potentially hurting the UK economy on a relative basis. Traders may be starting to see some of this relative weakness in the UK economy vs. other economies like the U.S. already unfolding. Asset markets are beginning to anticipate this with UK stocks trading relatively worse than U.S. stocks and UK yields struggling vs. U.S. yields. That relative asset performance has led to weakness in the British pound in the past but I have not yet seen that. Technically speaking, British Pound futures are beginning to look weak. Price as well as the lagging span have moved below the Ichimoku cloud pointing to a change in trend developing. Price has also moved below the 1-, 3- and 12-month moving averages and the moving averages are crossing lower too, giving more indications of downside price pressures. The Fibonacci Retracement of the move from January 2025 to February of 2026 would point to a move to 1.30 – 1.32 area vs. the current price at 1.3350. Traders are starting to pay up for downside options relative to upside options, but the overall level of volatility is still near the lows of the last 3 years, suggesting there is no imminent concern. 

The implied volatility surface indicated that option buyers may be well served to look to early July, namely the WG1N6 expiration, which trades at lower volatility than the expirations before and after it. Since the Fibonacci retracement may not contain the move lower, it could be ideal to have long convexity. However, since there are no imminent catalysts, it may be preferred to keep the overall cost low. This points to selling call spreads to fund downside puts. To be exact, I can sell 1.34 – 1.355 call spreads and buy 1.32 puts for zero cost. This call spread is struck at the confluence of the moving averages, which should be some resistance on a move higher. The risk is defined as the difference between the strikes. The reward begins on any move below 1.3200. This level is the 38.2% retracement zone and even if the move is simply a retracement to the 1.30 – 1.32 level, traders would make money at any level here. If the trend in the pound accelerates, because of trader concerns over the UK government, the UK economy or the relative performance of UK asset markets, traders would be long at 1.3200 puts and benefit from not only a move lower in futures prices but a move higher in implied volatility. 

Finding asymmetric reward to risk opportunities gives traders the chance to enhance portfolio performance. That is a major potential benefit of using options to implement views compared to the linear payout of futures. CME Group gives traders the flexibility to find and implement these views on a daily basis. 

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