EUR Vol: €STR big bang drives sharp repricing

Big bang

  • €STR catapults physical vs cash

  • CMS talk as high-strikes bid

  • 1m oversold? 

  • New structured issues


 €STR catapults physical vs cash

The planned big bang transition from EONIA to €STR CCP IRS discounting has seen a sharp repricing in physical vs cash swaption settlement. Among the big movers, 10y30y physical vs cash traded at 101bps today compared to 75bps a week ago, “It has traded several times on the way up,” confirmed one trader, adding it was most likely driven by dealers squaring up positions ahead of the scheduled €STR changeover on 22 June, 2020.


Following the switch, LCH-cleared physical trades will be discounted using €STR whereas bilateral (non-cleared) cash-settled trades will continue to be discounted using EONIA (EONIA is being calculated at €STR+8.5bps). As such, dealers prefer to own the physical settlement and sell the cash IRR settlement method - for more background see also €STR vol divergence


Trading in physical vs cash settlement has increased over the past several weeks although some desks have moved quicker than others. “It feels like we are starting to reach the end-game although maybe there are one or two dealers left who are still not certain about what it means when LCH starts discounting with €STR,” one trader suggested. As such, some pieces could still have a bit of juice left in them – for example, one trader felt 10y30y physical vs cash has a fair value around 112-115bps versus today’s trading price of 101bps (one trader noted that it was bid-on after trading).


When asked whether hedge funds have been tactically positioning for the changeover, sources were unsure. “Most likely it is dealers that are behind the bulk of the flow,” a trader felt. Still, it’s interesting to remember that back in 2018 some funds positioned ahead of the changeover from cash to physical as the standardized settlement method – see Swaption desks on reform


CMS talk as high-strikes bid

Local skew such as the 10y10y and 10y20y 200bps-wide collars have been better offered recently (although standing out as slightly unusual yesterday were the 5y20y collars that traded “strangely” higher, albeit in small size). Also getting a mention from yesterday were better offers in shorter-dated expiries, such as the 3m20y 50bps OTM receivers printing around 22bps.


By contrast, buying in high-strike skew has been a theme in recent days with prints going through in 10y2y 10%, 10y10y 6%, 10y10y 10%, 10yCMS and 20yCMS caps among others. “The very long-dated payers have seen some decent sizes trading,” a trader said.


Traders agreed the bids could be related to hedging of CMS structures amid a pick-up in activity. Note also that vega was a touch firmer today, possibly reflecting a link to CMS hedging, although one trader felt it was more a case of a higher price in 10y10y that helped to lift the entire grid.


Elsewhere in structured issuance, interest in callables has reportedly waned after interest peaked a couple of weeks ago, “It wasn’t so much that there were a lot of callables printing, but there had just been a few more when previously there had been none.” 


1m oversold?

In gamma, the risk-off backdrop saw buying interest first thing amid a decent dose of delivered vol as the Bund future rallied up to 65 ticks. The 1m10y traded at 115bps and was bid-on while 3m10y traded at 183bps.


However, the bids receded later in the day, “We got some decent delivered earlier today, but over the past few sessions the market has been pretty rangebound,” a trader said, noting there had been “huge selling” in listed Bobl options yesterday that had served to push OTC gamma lower.


A couple of traders expressed surprise that the 1m expiries have been so quick to give back all of the gains from the Dec 13 (UK election results) pick-up. The 1m10y shot up above 130bps after picking-up the date but has since fallen down to 109bps over the past week. “Probably the selloff includes some programme selling, but it all looks a bit brave,” cautioned one. "There is a binary risk from the UK election that does not appear to be reflected in the price," said another. Possibly some of the the drop in 1m euro vols has been in sympathy to the drop in shorter-dated dollar expiries where event risk has been getting priced out. 


Elsewhere, the top left has also been sold recently, with 1y1y printing at 14.5bps compared to 16bps last week. “The ECB feels pretty sidelined here with no real pricing of miscalculation,” a dealer felt.