Fed On Hold And Rates Lower For Longer

Eurodollar options trading around 2M contracts last 2 days
99.75 Strike Looks To Be Focus For Options Pin Risk
Treasury options less active, with about 500K contracts each day
Interest Rates Report

Interest Rates Report

The focus again has been the front end of the curve for option strategies, but we finally saw some flow in the further out contracts and with differing perspectives. We can only assume that the focus of trading has been on Libor, the only thing traders can feel confident about right now and that the lack of trading further out is due to so many variables surrounding COVID-19 and it’s lasting effects on the economy. But the flow on Friday was encouraging and a step in the right direction.

Big Trades

Thursday:

EDM0 99.625/99.75 call spread with the 98.75 puts as a stupid, paying 3.75 on 10K

July (EDN0) 99.50/99.625 put spread 1x2, selling the 2 legs at 0.75, 50K

July (EDN0) 99.375/99.50/99.625/99.75 put condor, paying 4 on 20K

Short July (E0N) 99.875 calls, paying 3 on 20K

Friday:

EDH1 99.25/99.50/99.75 put fly, paying 3.5 on 75K

EDZ0 99.50/99.625/99.875 call fly, paying even on 10K

EDM0 99.00/99.25 put spread, paying 2 on 45K

EDM1 99.625/99.75/99.875 call fly, paying 5 on 25K.

Interest Rate Options Quick Takes

1. The two July trades are basically looking for the same thing, which is for Libor and FRA/OIS to stabilize and for EDU0 to start trading down to the range of EDM0. Obviously the 1x2 is the cheaper version, but with the added risk of open downside loss on either one of those rates expanding. The Short July trade would seem to tell an opposite story. The last time rates were in the 0-25 basis point range, Eurodollars seemed to gravitate towards the 97 strike. So moving out another 12.5 basis points by targeting the 98 strike would almost suggest a negative rate environment, or at the very least on the cusp of NIRP. Which is why we haven’t seen a lot of outright buys of the 98 or 100 strikes. Those are typically sold in call spreads or other call structures to cheapen premium. And of course, this could simply be an upside hedge against something else, but it seems expensive for that purpose. Plus, that’s not much fun to talk about!

2. Of all the trades these last two days, the EDZ0 trade really caught my attention. Not that I’m a big fan of flies or pinning strikes (especially in the December contracts, where year-end funding shenanigans can have dramatic effects), but it’s an interesting trade, especially when you consider that the premium was flat.


Source QuikStrike

With a breakeven right at the 99.75 strike, it seems like a safe bet. And considering it’s the December contract, funding issues could certainly push it towards the 99.625 strike at expiration. But it’s still 6 months away, and a lot can happen in that time frame. This is an interesting trade that I will be keeping an eye on.

3. What a difference three months makes! The EDH1 put fly targets the 99.50 strike, while the EDM1 trade targets the 99.75 strike. With the Fed on hold and rates lower for longer, the 99.75 strike looks to be a decent focus when pinning strikes. That being said, both expirations are a long way off (EDH1 has 331 days to expiration and EDM1 has 442) and a lot can happen between now and then. I guess the silver lining here is that we have differing views on deferred contracts, which is encouraging. Over the last month or so it seems as if all the action has been focused on the front end of the curve and Libor dislocations.

About the Author

Albert Marquez is a Chicago-based options and futures broker, specializing in interest rates. You can reach Albert on Twitter@STIR_Report or stirreport@gmail.com.