Options Signal That Traders See Risk of Lower Treasury Yields

  • Swaptions skew is sending strongest signal since April
  • Bias is for options giving right to receive fixed rates

After an indecisive two months, options traders have finally staked out a stance on Treasury yields. The message they’re sending: There’s a risk yields will be lower by the U.S. Thanksgiving holiday.

An indicator known as the swaption skew, which traders watch for a hint of future yield moves, is giving off its strongest signal since April that investors are protecting against a scenario where yields decline.

As of Thursday, the skew for three-month options, which shows whether traders are more eager to lock in the right to pay or receive fixed rates on 10-year interest-rate swaps, shows relatively greater demand to receive fixed rates by November. That indicates traders are biased toward protecting against a scenario where yields decline.

“We’ve now seen some movement with a pickup in demand to hedge lower rates,” said Scott Buchta, head of fixed-income strategy at Brean Capital in Chicago. “This could be those with short positions hedging or people taking advantage of the rise in yields to add to bullish wagers.”

With global stocks rebounding from the rout of recent days, benchmark 10-year yields reached the highest in more than a week Thursday at 2.21 percent. They’ve risen from a four-month low of 1.9 percent touched Aug. 24.

Yet the turmoil in financial markets and signs of economic weakness in China have traders seeing only a 52 percent chance that the Federal Reserve will lift its target rate this year from near zero. Two weeks ago, that probability was above 70 percent.

On Wednesday, Federal Reserve Bank of New York President William Dudley said the case for increasing interest rates in September is less compelling because of worldwide market turbulence.