Carelessness
June 23, 2024 – Weekly Comment
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“They were careless people, Tom and Daisy- they smashed up things and creatures and then retreated back into their money or their vast carelessness or whatever it was that kept them together, and let other people clean up the mess they had made.”
― F. Scott Fitzgerald, The Great Gatsby
This quote, I believe, describes much of the western political class. Vast carelessness. It’s also a trait regularly on display in finance. What probably needs to occur is not a retreat back into their money, but rather a retreat of the money itself. A bonfire of the vanities ordained by the specter of Girolamo Savonarola.
On the week, changes were muted. US 2s through 30s rose 4.5 to 5 bps, with the 30y yield ending at 4.397%. The German 10y bund was up 5.2 bps to 2.412%. August Crude Oil (CLQ4) was one of the larger movers, rising $2.68/bbl to 80.73. Oil has shown surprising strength given, for example, Friday’s drubbing of copper (and gold and silver). HGU4 settled 442.85, the lowest close since mid-April, and is down 12.4% from the high close in May of 505.70.
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For the past couple of years, 100 bp wide call spreads have been heavily bought in SOFR contracts. First it was 9600/9700 call spreads and then 9700/9800 call spreads. In March/May 2023 some of these worked out, but for the most part it’s been a slow bleed into worthless settles.
On Friday, there was a new buyer of about 80k SFRH5 9675/9775 call spreads for 4.75. Settlement prices: SFRH5 9546.5, 9675c 6.75 with 12 delta, 9775c 2.25 with 4 delta. Open interest in the two strikes, +59k and +81k. There was also a new buyer of 50k TYQ4 111.5c, which settled 27 with a delta of 31 vs TYU4 110-16; open interest in the strike added 53k to 123k. Aug treasury options expire 26-July.
I’m just going to dig into the March SOFR call prices a little more, and outline some rough comparisons with the regional bank blow-up of March through May 2023. Recall that these bank failures, most notably Silicon Valley Bank, were precipitated by the rapid increase in Fed rate hikes which caused huge losses in un-hedged bond portfolios. Fed regulators were slow to identify problems, but depositors quickly recognized potential risks and sparked runs on the banks. At the time, SOFR contracts violently priced easing, but ultimately the Fed assured (and insured) everyone and continued to raise rates. With respect to the strength of the banking system and the Fed’s stewardship, this note from Friday’s Almost Daily Grants, (citing the FT) is worth a look:
The Federal Reserve has found weaknesses in the plans laid out by BofA, Citi, GS and JPM for how they would handle their own failures.
The US central bank and the FDIC on Friday said that, among the eight largest US banks, they spotted shortcomings in the so called “living wills” of those four lenders.
The FDIC viewed the weakness in Citi’s …as the most serious, saying the lender’s resolution plan was not credible or would not facilitate an orderly resolution under the US Bankruptcy Code.
It’s somewhat amusing as these banks are all too-big-to-fail. I wonder if Norinchukin has a ‘living will’. Someone is going to have to clean up that mess.
But let’s go back to the call spread. On Friday I posted a note on X. It’s a rolling chart of the 4th quarterly SFR slot, now representing SFRH5. The recent jump is due to a change in contracts, as 3-month calendars are about -25 to -30; SFRZ4 settled Friday at 9516 and H5 at 9546.5, so the shift to H5 in the 4th slot added 30 bps. The point is that we’ve had two big rallies predicated on easing…which ultimately never materialized. In the wake of SVB the Fed kept hiking, and the liquidity surge in Q4 of last year, punctuated by Powell’s dovish pivot at the December FOMC, also fizzled. In both cases, the 4th contract topped just over 9600. So, the 9675 strike in our call spread appears somewhat fanciful in terms of a target. Does that mean it’s an easy sale? Read on.
I looked back at monthly statements from April 28, 2023 and May 31, 2023. A client was long some SFRH4 9700c and 9750c. In April of 2023, the SFRH4 calls were 10.5 months from expiry, and of course in May they were 9.5 months away. Actually on May 31, the SFRH4 option expiration was 289 days away. This period was just after the SVB blow-up. Look at the prices:
April 28, 2023 (dte 322) This was near the high settlement for the SVB move.
SFRH4 settle 9605
SFRH4 9700c 34.50s
SFRH4 9750c 24.00s
atm SFRH4 9600 straddle 128.25
May 31, 2023 (dte 289)
SFRH4 settle 9562
SFRH4 9700c 24.75s
SFRH4 9750c 17.50s
atm SFRH4 9562.5^ 123.00
So in April 2023, the 9700c were 95 out-of-the-money and the 9750c were 145 out.
In May 2023, the 9700c were 138 otm and the 9750c were 188 out.
NOW
June 21, 2024 (dte 266)
SFRH5 settle 9546.5
SFRH5 9675c 6.75s
SFRH5 9725c 3.75s
SFRH5 9775c 2.25s
atm 9550^ 63.0
With not much difference in days until expiration, the atm straddle is about half the price. On May 31, 2023 the H4 9700c were 138 otm and settled 24.75. Currently, the H5 9675c are 128.5 otm, but they are only about one-quarter of the price at 6.75. The current 9725c at 3.75 are less than one-quarter of the price of SFRH4 9700 calls on 5/31/23. By the way, on Feb 28, 2023 (just before SVB) SFRH4 9700c settled 5.75 ref 9507.
I’m not saying the current buying of 9675/9775 call spreads is a great idea. But it’s clear, at least to me, that open-ended short calls, no matter how far away they look, are not attractive sales.
It’s a cautionary tale about selling SOFR upside. However, there is also a reasonable amount of press about a possible ‘Liz Truss’ moment in the US, given the constant deterioration in US budget dementia dynamics. Note that in the beginning of August 2022, the ten-year gilt was yielding 2%. Less than two months later, on September 27, 2022, the yield peaked at 4.5%. From the Guardian in October 2022:
Initially hailed by her supporters as “at last, a true Tory budget”, the ‘mini’ fiscal event included the biggest tax cuts since 1972, funded by a vast expansion in borrowing, and with only a vague attempt to argue it could be paid for by an unlikely economic boom.
The MOVE index ended Friday at 94.09. The range this year has been 127.02 in January, to 82.49 in May, so it’s closer to the lower end. VIX at 13.20. On a closing basis, high of year in April is 19.23 and low in May is 11.86. It seems as if current vol levels aren’t quite high enough to discount outliers that may be closer than they appear. I’m not in favor of outright put sales on longer maturities.
Upcoming events:
Stanley Cup Final: Monday night (no missive Tuesday)
Treasury auctions Tues, Wed, Thursday: $69b 2-yr, $70b 5yr, $44b 7yr.
Biden/Trump debate Thursday, 9pm EST.
PCE Prices Friday.
Note that the BLS will release the Employment data on Friday, July 5. Full trading day on July 5. Thursday, July 4 is not an official settlement day, screens are open until 1 pm EST. Stupid and careless.
Powell scheduled for semi-annual testimony on July 9. NOTE: The Semi-annual REPORT is released before the actual testimony. Not sure of the date yet.
French elections June 30 and July 7.
US Republican Convention July 15-18. Dem Convention August 19-22.
| 6/14/2024 | 6/21/2024 | chg | ||
| UST 2Y | 468.3 | 472.8 | 4.5 | wi 468.5/680 |
| UST 5Y | 422.4 | 426.9 | 4.5 | wi 426.7/265 |
| UST 10Y | 420.9 | 425.5 | 4.6 | |
| UST 30Y | 434.9 | 439.7 | 4.8 | |
| GERM 2Y | 276.3 | 278.9 | 2.6 | |
| GERM 10Y | 236.0 | 241.2 | 5.2 | |
| JPN 20Y | 173.9 | 179.7 | 5.8 | |
| CHINA 10Y | 229.7 | 226.0 | -3.7 | |
| SOFR U4/U5 | -112.0 | -108.5 | 3.5 | |
| SOFR U5/U6 | -38.5 | -39.5 | -1.0 | |
| SOFR U6/U7 | -7.5 | -8.0 | -0.5 | |
| EUR | 107.05 | 106.97 | -0.08 | |
| CRUDE (CLQ4) | 78.05 | 80.73 | 2.68 | |
| SPX | 5431.60 | 5464.62 | 33.02 | 0.6% |
| VIX | 12.66 | 13.22 | 0.56 | |
