UPDATE 1-Sterling investors start to price in Scotland vote risk

Mon Jul 21, 2014 11:21am EDT

(Adds details, fresh quote)

By Anirban Nag

LONDON, July 21 (Reuters) - Investors sought protection on Monday against the possibility of a Scottish vote for secession in nine weeks time after months of apparent confidence the 307-year old union with England will survive.

Until Monday, currency investors had not priced in the chance of a Scottish vote for independence, either by reducing sterling exposure or by hedging against future turmoil.

Scottish independence was at best a slight risk for most money managers, with opinion polls still showing more than 50 percent of Scots want to remain as part of the UK - far more than the third who want independence.

In fact, the pound has gained 3.5 percent against the dollar in the past six months to around $1.72 as investors focused primarily on the prospect of higher UK interest rates as a recovery gains traction.

But some investors started to buy options on Monday that allow them to hedge against the possibility of a Scottish vote for independence. This trend is likely to pick up in coming weeks, analysts said.

The two-month implied vol, which captures the Sept. 18 vote and the results, rose to around 5.2 percent from below 5 percent on Friday and 4.6 percent just a week ago.

Sterling two-month risk reversals, which gauge demand for options on a currency rising or falling, also showed a greater bias for sterling weakness than did their three-month equivalents.

"There is hedging against a surprise vote in the Scottish referendum and the two-month implied vols are suggesting that," said Peter Kinsella, currency strategist at Commerzbank. "Hedging against an outside chance of a split is pretty cheap."

Uncertainties include which currency an independent Scotland would use, membership of the European Union and whether the Scottish fund industry would move south, they said.

"The Scottish vote is starting to get factored in, especially given that August is a time when many people go away on holidays," said Ian Gunner, portfolio manager at Altana Hard Currency Fund. "The pound can be vulnerable to a shakeout." (Additional reporting by Jemima Kelly,; editing by Nigel Stephenson)

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