Posted by on July 12, 2017 11:33 pm
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Categories: Bloomberg L.P. Bond Bond Volatility Business Contract law Department of Labor Economy European Central Bank Finance Mathematical finance money Moneyness Options Strangle Technical Analysis US Federal Reserve VIX Volatility

Step aside “50 cent”, there is a new mystery vol trader on the block, one who is certain that a vol quake is about to strike US Treasurys.

According to Bloomberg, which first spotted the trade, someone just bet that bond volatility is about to soar. The unknown trader bought $10 million in out-of-the-money puts and calls on 10Y Treasury futs (a strangle). The outsized trade was spotted as it involved huge block sizes of about 63,500 on either side: “a strangle of that magnitude is rare, and possibly unprecedented” according to several rates traders who spoke to Bloomberg.

But just as notable as the size is the timing: the strangle expires July 21, giving the trade a shelf life of under 10 days before it expires worthless. Which means that the trader is confident enough about not only the size of the upcoming price swing to bet $10 million on it, but also when it will strike.  According to Bloomberg calculations, the theta on the trade is so high that just to recoup the premium, the yield on the 10Y would have to rise or fall about 10 bps from 2.38%, and preferably very soon.

Once the 10Y moves beyond 10bps, gains are unlimited, and the trader “stands to gain about $50 million on a quarter-point move in either direction from the starting level, which would involve approaching this year’s highs and lows for 10-year yields.”

Briefly this morning, the trade seemed like slam dunk when Yellen’s “dovish flip” sent the 10Y tumbling 6 bps before it stabilized around 2.32%.

But it’s not over yet: as Bloomberg observes there are enough potential catalysts in the coming week to send the 10Y surging… or tumbling:

The calendar over the next several days presents ample opportunities to rekindle volatility. In the U.S., political drama aside, the Labor Department releases consumer price index data Friday, which could influence the Fed’s timing for rate hikes and balance-sheet reduction. Retail sales data come out the same day. And, the day before the position expires, the European Central Bank announces a policy decision.

Backtesting the trade does not give high odds of success: not only has MOVE (the Tsy vol index) plunged alongside VIX, suppressing price swings but the 10Y yield has risen or dropped by more than 10 basis points just four times this year on a weekly basis, compared with 10 times in the same period of 2016 according to Bloomberg calculations. Then again, lightning may be about to strike twice: at last check, the MOVE was trading at levels just before the 2013 Taper Tantrum. We all know what happened to bond volatility after.

What about the mysterious trader’s counterparty – are they, inversely, betting that vol remains subdued for the next 10 days? This time the market maker appears to not be convinced that the prevailing lack of volatility will persist, and as Bloomberg concludes, “the total volumes traded in the two options Tuesday exceeded the open interest change” suggesting that the other side of the trade was likely hedged.

Finally, what is perhaps also notable is that while the trader has a very high conviction on a surge in rates vol, there was no comparable bet on exploding vol in any other asset classes, which may be an option for anyone wishing to piggyback on the trade, as such a sharp move in US Treasurys will certainly reverberate not only in US equities but in bonds around the globe.

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