The Next Big Treasuries Shock Could Come From a Huge Option Position
(Bloomberg) -- Treasury futures dipped Thursday, edging toward a key level for options traders which could trigger the next leg higher for yields.
The front-dated 10-year contract touched 127 1/4 in early Asia trading, close to the 127 level where a wall of bearish put options has shot up in size since the start of the year. That equates to about 1.92% in benchmark yields, which slipped to around 1.85% Thursday.
Futures hitting the level could potentially spark a fresh selloff in bonds as dealers who are short the option rush to hedge their exposure.
The options in question are the March 127.00 puts, where a wave of buying has lifted open interest -- the number of contracts in which traders have positions -- to 322,648 as of Tuesday’s close. That’s almost double the next-most-popular March put strike and amounts to a notional value of over $32 billion.
“There remains that monster 322k of put open interest at the 127 strike,” said Charlie McElligott, a cross-asset strategist at Nomura Securities in a note. “This level should continue to be monitored as an a potential ‘acceleration point’ on a break lower.”
Dealers typically hedge options positions with the underlying asset. In the current scenario, they’d sell Treasury futures as a dynamic hedge as cash yields rise. In the case of the 127.00 put, most of the position has been amassed this month, with 50,000 contracts bought on Jan. 3 and 30,000 on Jan. 12.
With risk also elevated in neighboring strikes above 127.00, selling U.S. 10-year futures as a hedge has the potential to lift yields above 1.95%, if not toward 2%. March options on Treasury futures expire Feb. 18.
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