USD Vol: ULC comes crashing in; Gamma cheapens

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The very ULC has come crashing in today as underlying rates bear flattened. Switches are active ahead of the FOMC. JPM favors a long vega position.

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  • ULC comes crashing in; Gamma cheapens  

  • Long vega bias in months ahead – JP Morgan

  • New structured notes



    ULC comes crashing in; Gamma cheapens   

    Treasuries have seen further bear flattening this afternoon with swap rates 7 to 21bps higher on the day. The $12bn 20y auction came through by 0.1bps compared to the 1pm bid side. Meanwhile First Republic shares are up 53% last. The vol surface has come crashing back in amid rate moves and a sense starting to build that perhaps things are starting to stabilize.


    “Possibly,” considered one trader that the vol market is starting to mark the end of the wild swings and the recent stupendous gains. 1m1y, having traded up at 71bps yesterday or around 313 annualized, traded down at 61bps today - or a roughly 43 normal cheapening on the day to around 270 annualized.


    The futures market is pricing in an 86.4% chance of a 25bps hike versus 13.6% of no move for the FOMC tomorrow, and the potential is for vol to come off further, sources judge. As it currently stands, parts of very ULC are still above GFC highs - despite today’s 15 to 43 normal cheapening in ULC gamma expiries.


    In interbank activity, switches were active ahead of the FOMC along with some outright trades. 1y1y traded at 141bps vs. 2y1y at 165bps in a switch, then 1y1y dealt at 139bps and last at 137bps, 6m2y traded at 205bps versus 3y10y at 1200bps, possibly, then 6m2y traded at 204.5bps and then down at 203bps, 2y2y dealt at 295bps versus 2y10y at 1037bps in a switch, according to the SDR.


    Further right, 3m5y traded at 295bps outright and also at that level versus 1m10y at 288bps, 1m5y traded at 199bps, 1y5y traded at 490bps outright and also at the same level versus 1y30y at 1421bps , 5y1y traded at 195bps versus 5y10y at1408bps, 1y10y traded at 770bps this morning and then traded at 765bps, according to the SDR.



    For USD option trades on the SDR see here and for volumes please see here.  



    Long vega bias in months ahead – JP Morgan

    Looking back on the price action last week, analysts at JP Morgan find it noteworthy that 6m2y implied volatility reached a high of 12.7bp/day the past week, “very close to the peak of 13.5bp/day reached in October 2008 during the Great Financial Crisis of '08.”


    “Indeed, even more broadly, the implied volatility surface of today bears a strong similarity to the surface at that time” and it believes that “it is by no means a given that we are past the worst of the current crisis, and much uncertainty lies ahead.”


    Nevertheless, JP Morgan finds it constructive “to look to the months that followed the peak in 2008 as a guide to what kinds of options positions might exhibit the most asymmetric risk reward in the months ahead.”


    From the analysis, JP Morgan finds that “although selling 6m2y volatility was profitable, this conclusion is somewhat by construction since we defined the historical period based on a peak in 6m2y” and thus, JP Morgan do not read much into the attractiveness of selling upper left volatility.


    However, it highlights “interestingly almost all the other outright volatility positions with asymmetric payoffs are all long volatility positions, with 10y10y exhibiting the best risk reward (in part because of attractive vol slide).” Therefore, JP Morgan recommends a long vega bias in the months ahead.


    Secondly, JP Morgan suggests that “tail switches involving selling volatility on short tails versus buying volatility on longer tails in the 5- to 10-year sector is likely to be an attractive theme in such periods” while lastly, it finds “no clear pattern appears to emerge with respect to vega neutral expiry switches” and thus it finds these are likely not particularly interesting as a theme.



    New structured notes

    For a complete review of USD MTN activity over the past week, please see USD MTNs.


    • Citigroup is working on a self-led fixed callable maturing Mar 2029 NC3 that pays 4.9%. EMTN.   


    • Dow Chemical is working on a self-led fixed callable via InspereX maturing Mar 2053 NC6m that pays 5.8%. Domestic MTN.


    • Dow Chemical is working on a self-led fixed callable via InspereX maturing Mar 2033 NC6m that pays 5.15%. Domestic MTN.


    • Dow Chemical is working on a self-led fixed callable via InspereX maturing Mar 2028 NC6m that pays 4.7%. Domestic MTN.