The past week has seen a surge in option bets which pay off as more Federal Reserve hikes are priced in, though all of them are targeted at rates two or three years from now.
Given the Fed’s mantra of lower rates for longer, traders don’t expect hikes this year and are unwilling to pay up for expensive options with long-dated expiries. The solution: a rush into so-called mid-curve options with short-term expiries but are priced off rates a couple of years out.
This allows traders to focus bets on 2023 and 2024, without having to hold the options for more than a few months.
Volumes in this part of the option market have surged to the highest since November in some cases as U.S. President-elect Joe Biden prepares to release proposals for a stimulus package worth trillions of dollars onThursday, spurring wagers on additional rate hike premiums in Eurodollar futures.
This has come at the expense of conventional options, where volumes have dropped to the lowest in about three months.
Eurodollar Options Activity Jumps With Bets on Higher 2024 Rates
While a huge variety of bets have been made, there has been one stand-out in what’s known as March 2021 three-year mid-curves. More than 100,000 puts were traded betting on higher rates in the March 2024 contract, even though the options themselves expire the same month this year.
Further out the curve, Treasuries extended their slide on Tuesday with intermediates continuing to lead the selloff. This mid-curve sector of the curve has significantly underperformed since the start of the year, as pricing firms for a Fed hike cycle. The 3s7s30s U.S. yield fly rose an additional basis point Tuesday, onto the cheapest level since April.
— With assistance by Edward Bolingbroke
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