Jan 5, 2014. Interest rate option comment

US interest rate options ended the week reflecting a market bias of moving Fed action to a somewhat more forward time frame.  This is apparent in, 1) tame vol levels at the longer end, 2) interest in buying puts moving forward on the curve, and 3) deferred midcurve straddle calendars narrowing.

In a longer time frame view, TY at-the-money implied vol is rather subdued, running around 5.1 to 5.2% with the ten year yield hovering around 3% and supply coming next week in tens and thirty year bonds.  Last year when yields jumped as the market became concerned about tapering and the possibility of Fed tightening, vol was much higher.  In early July, TY implied hit nearly 8%, and in early September when the ten year yield reached 3%, TY vol was around 7.7.  On Friday, TYH 123 straddle settled 1’53 at 5.2.  If implied volatility was at the same level as the last time we were at 3%, the straddle would be a point higher (8% would give a straddle price of 2’53).  In the event, the market has adjusted to tapering at the long end.  There is clearly an absence of panic for a surge to higher yields this time around, as reflected by relative lack of put skew.  However, there are some fissures evident in the calm facade.  More on that below…

In terms of treasury open interest, the largest strike is TYG 121.5 put, with 121k open (12 delta).  The next highest is TYG 123.5 put with 104k open (59 delta).  Large buyer last week of 122.5/121.5 put spreads; the 122.5 strike is about 8.5 bps away.  February treasury options expire 24-Jan, the week prior to the FOMC.  While there has been some rolling of positions into March, we would expect the pace to pick up appreciably this week.  The biggest open interest strike in March is the 123 put (corresponding to 3% yield) which has 53k open.  TY futures have 2.217 million open interest.

In eurodollars, the picture is a bit clearer with respect to the MARKET giving the FED forward guidance on tightening.  There are several midcurve put strikes with open interest near or above 200k.  For example, Blue March 9700 puts have 193k open.  That’s due to large positions having been taken several weeks ago in Blue March 9750/9725/9700 put butterflies and 9750/9700/9650 put flies.  But on Friday, we saw a seller of 25k of the 9750/9725 put spread, (an exit of the upper put spread on the fly) and a buyer of 25k Green Feb 9837 puts.  May not have been the same player, but the bearish net adjustment forward on the curve was also reflected by weakness in red and green futures after Bernanke spoke on Friday.  (Red pack closed -3.375 and Green pack -2.25). The largest open interest options are Green Feb 9837 puts as noted above (216k open), and the Green March 9850 puts with 232k open.  Both of these are related to large put condor purchases a few weeks ago.  It’s worth mentioning that most large bearish positions taken recently are capped, that is, put flies and condors.  There is little expectation (or protection) for a violent sell off.

One last note concerns straddle spread levels between green and blue midcurves.  On the futures curve, the widest pack spread is still greens/blues around 111 bps.  However, reds/greens have been widening relative to green/blue and that’s also clear in straddle spreads.  For example, on Friday Green June 9825^ settled 55.0 and Blue June 9712^ settled 62.0, a difference of 7 bps.  But on 12-December, Green June 9850^ was 56.0 while the Blue June 9737^ 70.0, a difference of 14 bps.  A fairly significant compression in the space of a few weeks, (in ALL green to blue straddle spreads), which portends a forward shift of volatility.

Posted on January 6, 2014 at 4:37 am by alexmanzara · Permalink
In: Eurodollar Options

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