Debt Options Traders Capitulate on Hedges for Lower U.S. Rates

Options traders are making an about face on whether long-term government debt yields can go lower.

The difference between volatility, a gauge of price and demand, on three-month options that allow investors to lock-in paying fixed rates on 10-year interest-rate swaps and those that grant the right to receive them turned positive Thursday for the first time since November. The so-called swaption skew shows a bias for hedges against 10-year rates rising.

The measure reached a more-than-one-year extreme leaning toward contracts that profit as yields fall in January. U.S. 10-year Treasury yields rose for a fourth day as rout in European debt while the Federal Reserve’s policy statement Wednesday indicated that policy makers have left open the possibility of benchmark borrowing costs rising this year.

“There isn’t that fear there was before, because even if yields go down, people don’t think they will go down to a level that will hurt their core positions,” said Todd Colvin, a senior vice president at Chicago-based Ambrosino Brothers, who sees similar patterns in exchange-traded options on 10-year Treasury note futures, with demand declining for calls that profit if yields fall.

“People are not willing to pay the rent on these options anymore for something they just don’t know will happen,” said Colvin. Ambrosino is a futures and options execution firm.

The Treasury 10-year yield reached 2.11 percent Thursday, according to Bloomberg Bond Trader data, the highest since March 13. The rate on a similar maturity interest rates swap rose as much as 0.07 percentage points to 2.19 percent. Swap rates typically move in the same overall direction as Treasury yields.

In an interest-rate swap, two parties agree to exchange fixed for floating payments over a period of time with the floating rate typically based on changes in the London interbank offered rate, or Libor. Swaptions are options on those contracts.

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