UK markets bet on post-election gyrations, calm for now

* Overnight sterling options spike to 5-yr highs

* Stock market volatility index also climb

* Gilt yields rise on global bond selloff (Adds stock market close, fresh comment)

By Anirban Nag

LONDON, May 7 (Reuters) - The cost of protection against overnight swings in the British pound jumped to its highest since the last parliamentary elections in 2010 on Thursday as Britons headed to vote in the most unpredictable poll for decades.

A rise in currency and stock market option volatility indexes reflected uncertainty stemming from the vote, and Britain's top share index closed weaker than its European peers.

But sterling and gilts broadly tracked international trends, adding to a relatively resilient performance this year in the face of doubts about whether the poll will generate a durable government.

Polls have shown the ruling Conservatives and opposition Labour Party neck-and-neck, making a "hung parliament" in which no single party has a majority, the most likely outcome.

As a result, some hedge funds and investors were willing to pay more to protect against sharp moves in the pound in the hours and days just after the election.

"There is a lot of tension in the short-term but with no particular upside or downside view," said Gian Marco Salcioli, Head (Other OTC: HEDYY - news) of FX Sales at Italy's Intesa Sanpaolo Banca IMI.

The overnight sterling/dollar implied volatility option , which expires on Friday when the results are due, rose to 33.125 percent, its highest since at least mid-2010, according to Reuters data. This also captured fallout from a U.S. jobs report due on Friday.

The jump in the premium suggests investors are factoring in a trading band of 2 percentage points, or a move of around three cents either way, in just one day.

One-week implied volatility traded at 18.75 percent, near its highest since Britain's 2010 parliamentary election .

"The near-end costs of seeking protection are still very high," said Peter Kinsella, currency strategist at Commerzbank (Xetra: CBK100 - news) . "But if a Conservative government comes to power, we could see them fall rapidly."

RELIEF RALLY

Traders in London's right-leaning City say a rally in sterling and stocks is likely if it emerges that the Conservatives are in a position to form another coalition government. They worry that a Labour-led coalition would mean more regulations and market-unfriendly measures.

However, they are also concerned about a Conservative promise to hold a referendum on whether Britain should leave the European Union. In general, most investors worry that any weak minority government will not be able to deal with Britain's twin fiscal and current account deficits.

Sterling was down 0.1 percent at $1.5226, but was trading firmer against the euro at 74.09 pence, recovering from a three-month low against the euro of 74.82 pence per euro.

The blue-chip FTSE 100 index, which hit a record high of 7,122.74 points last month, was down by 0.7 percent at 6,886.95 points, having hit a one-month low earlier.

Societe Generale (Paris: FR0000130809 - news) stock market strategists told investors to stay clear of UK equities after the elections because of fading growth momentum, the twin deficits, the FTSE 100's exposure to oil prices and a weakening euro.

British 10-year government bond yields hit their highest level since November as part of a further wave of heavy sales of sovereign debt on international markets. The 10-year yields were roughly flat at 1.91 percent, having risen to 2.07 percent. (Additional reporting by Patrick Graham, Sudip Kar-Gupta and William Schomberg)