Hedges Against U.S. Yield Rise Surged Before Debt Vote, CME Says

Trading in options that profit if Treasury yields rise surged before the House of Representatives voted yesterday to suspend the U.S. debt limit for four months.

Eighty-three percent of the volume on Jan. 18 in options on 10-year Treasury note futures was in puts, which gain in value if the underlying futures price falls, according to data from CME Group Inc., the world’s largest futures exchange. During 2012, put volume on the 10-year futures never rose higher than 79 percent, CME data show.

Before yesterday’s congressional vote, speculation had increased that U.S. politicians might fail to extend the debt limit and depress government securities prices.

“The trigger here was likely the debt-ceiling vote,” said Bluford Putnam, the chief economist for the Chicago-based CME Group, in a telephone interview. “Also, the economy is improving and the portfolio-management community is feeling the fear-trade is gone and that yields could rise.”

The Republican-led House voted to suspend the nation’s $16.4 trillion borrowing limit until May 19. The measure goes to the Senate where Majority Leader Harry Reid said lawmakers will pass the bill unchanged and send it to President Barack Obama.

On Jan. 22, the day before the House vote, put volume accounted for 77 percent of total option turnover on the 10-year futures.

Treasury Yields

The yield on the 10-year note reached a one-week high of 1.89 percent on Jan. 18, before retreating to trade today at 1.84 percent. Prices move in opposite direction of yield changes. The 10-year futures contract touched as low as 131-22/32 on Jan. 18, and closed yesterday at 132-9.5/32.

“People that were holding Treasuries for a flight-to-quality purpose don’t feel they need to do so as much anymore,” New York-based Putnam said. “There is less fear now about the government shutting down.”

Global investors surveyed Jan. 17 by Bloomberg said the state of America’s finances represents the greatest risk to the world economy.

With the government weeks away from reaching its borrowing limit, 36 percent of respondents to a quarterly Bloomberg poll said the nation’s fiscal woes was the biggest threat compared with 29 percent who choose Europe’s sovereign-debt crisis and 15 percent who name a slowing Chinese economy.

Open interest in puts on the 10-year note futures outnumbered that for calls on Jan. 22 by a ratio of 1.6 to 1, CME Group data show. Open interest is the total number of contracts that have not been closed, liquidated or delivered.

Puts grant the right, but not the obligation, to sell the underlying futures. Calls grant the right to buy. Futures contracts are agreements to buy or sell a specific amount of a commodity or security at a specific price and time.

Treasury notes with a maturity of between six and one-half years and 10 years from the first day of the delivery month may be delivered under the CME’s 10-year note futures contract.

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