Trading in options that profit if implied yields on Eurodollar futures expiring in two years rise has increased this month relative to those that gain should they fall, hedging the risk that interest rates won’t stay low through the end of 2014.
Prices of Eurodollar futures contracts that expire in 2014 rose to this year’s high after the Federal Reserve said in January that the economy may warrant holding the target lending rate at zero to 0.25 percent at least through late 2014. Prices have fallen since Fed Chairman Ben S. Bernanke refrained last week in congressional testimony from signaling more asset purchases under quantitative easing are imminent.
Volume in the March so-called mid-curve put options, whose value is based on Eurodollar contracts expiring in 2014, has been four times that for calls since March 1, according to CME Group data tracked by R.J. O’Brien & Associates, a Chicago-based futures brokerage. Open interest in puts rose by 200,000, while that for calls increased by 13,000 through March 6. Puts grant the right to sell the underlying futures, and calls grant the right to buy. Open interest is the total number of contracts that have not been closed, liquidated or delivered.
“The data suggest to us that people are buying puts,” said Todd Colvin, a senior vice president at R.J. O’Brien. “People that are long in this area of the curve may be hedging the chance of something happening to trigger a rise in rates. There has also been some normalization in rates since January, when the Fed pledged to keep rates low through 2014.”
The March 2014 Eurodollar contract traded at 99.225 yesterday, for an implied yield of 0.775 percent. That’s up 0.180 percentage point from an implied yield of 0.605 percent on Feb. 2, when the contract reached the year’s high of 99.395. The implied yield was 0.840 percent on Jan. 24, the day before the Federal Open Market Committee extended its pledge to keep borrowing costs low.
The implied yield on Eurodollar futures, moving in the opposite direction of price, reflects expectations for the three-month dollar London interbank offered rate and changes in the Fed’s monetary policy. A put option increases in value if implied yields of the underlying futures rise, while a call option’s value would decline.
Bernanke said following the January policy meeting that the central bank was considering another set of purchases after buying $2.3 trillion of Treasury and mortgage-related bonds from 2008 to 2011 to stimulate the economy. He affirmed last week in congressional testimony that interest rates are likely to stay low at least through late 2014 without offering any indication that further monetary easing was likely.
Eurodollars are dollars held in commercial banks outside the U.S. A futures contract is an agreement to sell or buy a specific amount of a commodity or security at a specific price and time.
The London interbank offered rate, or Libor, for three- month dollar loans was fixed yesterday at 0.4746 percent, down from a high this year of 0.5825 percent on Jan. 3.
To contact the reporter on this story: Liz Capo McCormick in New York at firstname.lastname@example.org
To contact the editor responsible for this story: Dave Liedtka at email@example.com