Tidal wave of treasury options adds risk to Jackson Hole
(Bloomberg) – A flood of Treasury options set to expire on Friday could dictate the bond market’s reaction to Federal Reserve Chairman Jerome Powell’s long-awaited speech on the economic outlook.
More than 2 million options in September’s 10-year contract, or 63% of total options open on treasury bills, expire at the end of trading on Friday, increasing the prospect of volatility following remarks by Powell which should start at 10 o’clock. New York time.
For months, Treasury options traders have been racking up hedges against swings in 10-year yields, in part with this week’s Jackson Hole Symposium in mind as a potential turning point for Fed policy. Yields rose briefly on Thursday after some of the central bank’s top hawks urged policymakers to act quickly to slow bond purchases. Powell adopted a more patient tone.
At Wednesday’s close, most of the risk is concentrated around several option structures which equate to 10-year yields of around 1.5%, 1.34% and 1.21%, against the current rate of ‘about 1.34%. These levels are distinguished by their potential to influence trading following Powell’s speech, if brokers and option holders reduce their vulnerability to market movements leading to options expiration and shift the price of contracts to 10-year term near the strike price.
The overall market tilt leading up to the Jackson Hole rally looks relatively balanced. Data from JPMorgan Chase & Co. shows that the bank’s clients have pulled out of short bets – bets on the trade of reflation and bear escalation – and are near the most neutral position since. months. Meanwhile, the options bias – representing the relative appetite for puts and calls on the 10-year notes – has been mostly calm.
As the market has moved to a more neutral stance, some strategists now view Treasuries as expensive. JPMorgan strategists, for example, in an Aug. 20 report recommended staying positioned for higher 10-year returns based on the latest wave of viruses without significantly damaging the economy. Those at Citigroup Inc. said a position that reflects a steeper 2- to 10-year curve makes sense, while strategists at Barclays Plc pointed to swaption data that suggests traders remain positioned for a sell-off.
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One of the highlights of options activity ahead of Friday’s speech was the first major long volatility bet in weeks, targeting the 10-year U.S. yield to break above 0.93% or 1.50% d ‘by the end of November. Other notable trades included hedging a rapid drop in 10-year yields to 1.15% on September 3. A combined bonus of $ 13 million was paid for these bets.
Traders’ conclusions on Friday on the path for the Fed’s reduction in asset purchases should also influence bets on when the central bank will raise benchmark rates close to zero. Overnight swaps and Eurodollar futures show that the first rate hike is expected in early 2023, the second by June 2023.
In Eurodollar options, a notable theme over the past week has been a hedge against the three-month Libor falling to zero – by around 0.12% now – via the March 2022 contracts. This is not an outright bet on rate cuts, it may indicate that at least one speculator sees the risk of a more accommodating Fed policy than currently expected.
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