Option probabilities spell possible trouble for Treasuries

Since the key dates are known, it allows option traders to focus on a specific expiration month. Based on the debt ceiling date of Feb.7, I wanted to look at the March 2014 TLT option chain for clues about what the options marketplace is indicating about any future event(s) and the potential impact on Treasury prices.

The first thing I did was to check the implied volatility of the various monthly option expirations and I found a glaringly obvious warning signal. The table shown below demonstrates that implied volatility is higher on the March 2014 options than the December or January expirations.

The March 2014 option series has 10.46% more implied volatility than the December 2013 monthly option series based on the November 14th close. As can be seen above, the March monthly expiration has considerably higher implied volatility than the rest of the expiration series leading up to March.

Essentially this implied volatility skew is telling us that the option market believes that volatility will increase as we move into the March to April time frame. This corresponds with my expectations that Treasury’s may see serious price volatility late in the first quarter of 2014. The timeline fits nearly perfectly with the next debt ceiling discussion.

The next examination I look at is standard deviation based price levels to ascertain clues about the market’s expectations in the future. The TLT March 2014 monthly put option chain is shown below with the 1 standard deviation and 2 standard deviation price points highlighted.

The chart above illustrates the closing price levels on November 14, 2013. As can clearly be seen, the 99 strike is roughly 1 standard deviation (68% probability) lower from the closing price of $104.52/share. A 2 standard deviation move (90% probability) corresponds with the 91 put strike.

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