USD Vol: Smile fills in; Implieds fall further to more familiar levels

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The vol surface fell for the third consecutive session, bringing gamma to more recognizable levels, albeit still elevated. More skew trades.

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  • Smile fills in; Implieds fall further to more familiar levels

  • Best trades to express short vol positioning – Citigroup

  • New structured notes


    Smile fills in; Implieds fall further to more familiar levels

    Treasuries are seeing a modest seesaw session within a limited 5-6bps range and small realized volatility, with swap rates within 2bps of unchanged. The vol surface is decompressing further for the third consecutive session and levels are starting to look more recognizable as near to normal, especially the more sedate right side.


    Gamma is off the morning lows, but 3m expiries are still around 3 to 17 normals lower on the day while 6m expiries are roughly 2 to 11 normals softer. 1y expiries are around 1 to 6 normals lower – with the left side continuing to see the largest drops across the board.


    The ULC remains quite elevated, but it has come down significantly from the recent highs. For example, 1m1y which traded above 300 annualized (313) is back down to around 216 annualized, but still well above the roughly 100 annualized level seen before the banking crisis. 1y1y is back around 163 annualized or a drop of around 6 normals today, from a high of around 196 annualized and a pre-blowup level of around 145 annualized.


    Meanwhile, as the market has calmed down, skew activity has been busy and with more levels elucidating the shape of the smile, sources say. “You can start to see the shape a little,” with more intermediate risk reversals going through along with the longer dated and short dated skew, a source pointed out.


    In skew activity today, for example, in short expiries, 6m1y 100bp each way risk reversal traded at -10.5bps while 6m30y 50bps each way risk reversal traded at -2.5bps then -6bps and then -5bps, according to the SDR, after seeing a market of -15bp/+1bps yesterday, according to sources.


    In intermediate skew, 1y30y 100bp each way risk reversal traded at +24bps and 3y30y 100bps each way dealt at the same level as yesterday at +77bps. Meanwhile, 10y10y 100bp each way risk reversal traded at +89bps and then +90bps. Also, “5y10y stuff is definitely payers over,” one source noted, with trading in the 100bp each way risk reversal at +70bps yesterday.


    As for outright ATM vol trading, 6m2y traded at 191bps, a wedge of 2y1y vs. 2x3 dealt at 19bps, 2y2y dealt at 295bps, 5y2y traded at 368bps, 1y1y traded at 132bps and may have dealt as low as 124bps, but is now around 127bps mid, 1y5y traded at 478bps earlier, according to the SDR.


    In longer tails, 1m10y dealt at 262bps and then 265bps, 3m10y traded at 420bps, 1y10y traded at 748bps, 3y10y traded at 1181bps and then 1185bps, 5y10y traded at 1397bps, and 5y30y traded at 2681bps, according to the SDR



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



    Best trades to express short vol positioning – Citigroup

    Analysts at Citigroup offer what they view are the “best expressions” for shorting vol in both the gamma and vega space once the ongoing banking stress has stabilized:


      Short Golds convexity via futures/swaps (short gamma): “Along with the jump in implied vols, Blues/Golds convexity adjustments have increased…. Currently both Blues and Golds convexity adjustments look high both outright and relative to our model. Given that our model fair values are primarily dependent on the cap/floor implied vols, we believe that shorting the convexity adjustments is a better way to monetize the elevated implied vols than selling rates options. Currently the Golds convexity adjustment is about 11bps too high relative to our model, which appears to be even more dislocated than the Blues (5.5bps too high to our model).”


      Costless 1m10y receiver ladder (short gamma with lower yields): “While ATM vol has peaked, short-dated receiver skews, such as 3m10y and 3m30y, have continued to richen to their multi-year extremes… The sharp increase in the receiver skew has triggered a bullish duration signal in our indicator, which is consistent with our view that the rate rally has more room to go. But given the extent of the rate rally in the last 2 weeks, we expect further outperformance to be more gradual. We favor a costless 1m10y receiver ladder as a cost-efficient way to express this view by monetizing the still elevated ATM vol and rich receiver skew. The structure has a 1m breakeven of roughly 52bps below spot 10y. The risk is that a renewed banking fear could cause 10y rate to decline below the 1m breakeven in a sharp flight-to-quality rally.”


      Long MBS basis versus Tsy (short vega): “Given the embedded short optionality in MBS, the mortgage basis versus Treasury tends to exhibit a broad relationship to intermediate swaption vols, where the higher/lower rates volatility would be compensated with a higher/lower excess yield. Currently, the MBS basis appears to be too wide relative to the 1y10y swaption vol, based on the past 1 year regression. Hence, instead of selling swaption straddles, investors can implicitly short 1y10y vol at a more attractive level by being long MBS against Tsy.”



    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 2028 NC1 that pays 5.15%. Domestic MTN.


    • Royal Bank of Canada is working on a self-led USD extendible with initial maturity Mar 2025 and then extendible to Mar 2033 that pays 5.78%. Domestic MTN.  


    • CIBC is working on a self-led USD extendible with initial maturity Apr 2024 and then extendible to Apr 2025 that pays 5.05%. Domestic MTN.


    • Royal Bank of Canada is working on a self-led CAD extendible with initial maturity Apr 2028 and then extendible to Apr 2033 that pays 5%. Canadian.