Treasury ETF Volatility Hits Three-Year Low Before FOMC: OptionsNikolaj Gammeltoft, Aubrey Pringle and Liz Capo McCormick
The cost of betting on swings in an exchange-traded fund tracking Treasuries fell to the lowest level since 2010 on speculation volatility will diminish as the Federal Reserve delays plans to taper stimulus.
Implied volatility, used to gauge the cost of options, for the iShares 20+ Year Treasury Bond ETF dropped 35 percent to 11.56 from a June peak, the lowest level since March 2010, according to data compiled by Bloomberg on three-month contracts with an exercise price near the shares. The fund has climbed 6.1 percent since a two-year low in August.
Signs that the U.S. economy isn’t expanding fast enough to withstand a reduction in stimulus has sent 10-year Treasury yields to the lowest level in three months. Reports this month showed September job growth was weaker than estimated and the 16-day government shutdown took an estimated $24 billion out of the world’s largest economy. Fed policy makers are scheduled to gather Oct. 29-30 to consider whether to slow down the $85 billion in monthly bond buying.
“They’re unlikely to taper for the first number of months into the new year,” Stuart Freeman, chief equity strategist at Wells Fargo Advisors LLC in St. Louis, said yesterday in a phone interview. The firm oversees about $1.3 trillion. “The jobs data suggest the economy isn’t as strong as they had hoped for and the budget debate in Washington probably caused more political wrangling than they might have expected.”
Traders are reducing expectations for swings in the iShares Treasury ETF going into next week’s Federal Open Market Committee meeting. Implied volatility for one-month options with a strike price closest to the fund was 20 percent higher than the actual swings in the last 20 days, data compiled by Bloomberg show. That’s down from Oct. 15, when the measure of options prices was 65 percent above realized volatility, the biggest gap since December.
The Bank of America Merrill Lynch MOVE index, which tracks expectations for swings in U.S. debt yields, has dropped 45 percent to 63.05 since Sept. 5, finishing yesterday at the lowest level since May.
U.S. payrolls grew by 148,000 in September, versus the median forecast of a 180,000 advance by 93 economists in a Bloomberg News survey. The data show that the economy had little momentum leading up to the partial federal government shutdown, which Standard & Poor’s estimates shaved at least 0.6 percent off fourth-quarter growth.
The below-forecast payroll growth in September solidified that the Fed won’t taper bond purchases this year and also assured that it will keep its zero to 0.25 percent band for its target rate steady until 2016, Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said Oct. 22 in a Bloomberg Radio interview. The 10-year yield will continue to trade near 2.5 percent, he said.
“The Fed’s scaling back of bond purchase in October is off the table and December is still a very unlikely possibility,” Ward McCarthy, chief financial economist at Jefferies LLC in New York and a former economist at the Federal Reserve Bank of Richmond, said in a telephone interview. “Treasury yields will stay in a range or even move lower, given the risks that the uncertainty and frustration caused by U.S. fiscal policy will affect consumer and investment spending.”
The 10-year yield, used to help set interest rates for everything from car loans to mortgages, slipped one basis point, or 0.01 percentage point, to 2.5 percent yesterday.
The rate is below the 2013 closing high of 2.99 percent reached Sept. 5, before the Fed surprised economists and strategists by saying that it would maintain its bond purchases. The consensus forecast was for some reduction in the pace of stimulus. Economists now predict the central bank will keep its $85 billion of monthly bond buying until March, according to a Bloomberg survey conducted Oct. 17-18.
It’s precarious to bet on lower Treasury volatility because investors can’t predict when the central bank will adjust monetary policy, according to Todd Rosenbluth, director of ETF research for S&P Capital IQ.
“The timing is dependent upon data, and the data is changing all the time,” Rosenbluth said yesterday in a phone interview from New York. “There could be some volatility in Treasury-based products as the market continues to change its opinion on when tapering will happen.”
Fed Chairman Ben S. Bernanke said in May that the central bank may start to slow stimulus, spurring a drop in Treasuries as the yield on the 10-year benchmark note climbed to a two-year high last month. In the Fed’s Beige Book business survey from Oct. 16, eight central bank districts said the economic expansion held steady amid “uncertainty” from the U.S. fiscal deadlock, while four reported slower growth.
The Chicago Board Options Exchange Volatility Index, or VIX, which tracks the cost of Standard & Poor’s 500 Index derivatives, retreated 1.6 percent to 13.20 today. Its European counterpart, the VStoxx Index, retreated 6.4 percent to 15.56.
The most-owned bullish options on the Treasuries ETF were October $106 calls, expiring this week, and November $110 calls with an exercise price less than 2 percent below the last close, data compiled by Bloomberg show.
The cost of hedging against a decline in the fund, which tracks U.S. debt maturing in 20 years or more, has retreated to the lowest level in two months. Puts with an exercise price 10 percent below the fund cost 2.06 points more than calls betting on a 10 percent increase, according to data on three-month contracts. The price relationship known as skew reached 3.39 points on Aug. 22, the most since April 2012.
“If people perceive that we’re in a low economic growth environment within a strong Fed stimulus framework, then that’s a recipe for a degradation of TLT implied volatility levels and a lower VIX,” Michael Purves, head of derivatives research at Weeden & Co., said yesterday in a phone interview.