USD Vol: Some short covering propels vol higher

Some short covering propels vol higher

Treasuries have sold off with yields 6.5bps to 9bps higher on the day, led by the front end. A 25bps hike in May appears to be in the bag at this point, with futures seeing a now 88.7% probability of a 25bps hike (versus around 72% a week ago).

The vol surface is firmer with exception of very short-dated gamma on 1y tails, with buying emerging today after the selling into and out of CPI last week.

The move is bucking the directionality of lower vol against higher rate pattern (and vice versa higher vol versus lower rate) that has been the distinguishing mark of recent vol moves amid the March banking crisis - and that had followed the premium for receivers over payers in short expiry skew.

A source noted that dealers are short gamma and are likely covering some of the shorts. “Honestly, the market is just on edge, I think,” the trader added. Likewise, EUR vol is also higher today, on profit taking of short positions (see Total Derivatives). 

3m expiries are around 2-3 normals in 3y to 10y tails while the wings lag. 1y expiries are around 0.5 to 1.5 normals higher on the day while longer expiries are unchanged to up roughly 0.5 normal.

In interbank activity today, starting on the left side, 1m2y traded at 72bps and 72.5bps and last at 73bps, 9m 1y traded at 102bps, 6m2y dealt at 163bps, 6m3y traded at 231bps, 7y2y dealt at 377bps and 5y2y dealt at 353bps, according to the SDR. 

Further to the right, 1y5y dealt recently at 450bps, 3y5y traded at 674bps, 4y5y dealt at 736bps, 5y30y traded at 2585bps and 2580bps, 1y30y traded at 1332bps and 1337bps, 6m10y dealt at 530bps, 1y10y traded at 720.5bps, 723bps and 724bps, 1m10y dealt at 215bps and 1wk10y dealt at 96.5bps, and 3m25y traded at 597bps and 600bps, according to the SDR.

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

Elevated jump risk supports long gamma view – JP Morgan  

Analysts at JP Morgan favor maintaining its bullish view on gamma and continue to caution against selling short expiry volatility. For one, “jump risk favors long gamma positions, thanks to the nonlinear nature of gamma returns with respect to delivered volatility.” As a result, it believes “the existence of elevated jump risk lowers the breakeven level of delivered volatility on non-jump days.”

“One way to see the elevated nature of jump risk currently is to look at the volatility of yields between one day’s close and the next day’s market-open” and JP Morgan points out that this close-to-open-volatility, which has been one of the bank’s gauges of jump risk, “has spiked significantly since the banking turmoil began and continues to be at / near highs of this hiking cycle.”

“One reason for this elevated jump risk is of course poor liquidity, and market depth has not recovered back to its pre- banking crisis levels” and JP Morgan believes that “this is unlikely to materially change until the evolution of credit tightening and its economic impacts as well as the policy path become much clearer, which is likely to take some time.” Therefore, it views “persistent jump risk is likely to be a factor to contend with in coming weeks.”

Further, JP Morgan finds that the impact of elevated jump risk “is readily apparent from a decomposition of returns on delta hedged straddle positions.” Indeed, “although delta hedged straddle returns were negative over the past month because of large declines in implied volatility…gamma P/L (net of theta) was sizeable enough to offset a significant fraction of the negative vega P/L, especially in the short-tail sector.” Thus, the bank suggests “the implication going forward is that short gamma positions are highly vulnerable to elevated delivered volatility in the current environment, should the downward trend in implieds slow down or reverse.”

For specific ways to maintain a long gamma position, JP Morgan favors vega-neutral straddle calendar spreads in the 30-year tail sector, highlighting that the 6m30y minus 1y30y implied volatility differential “has cheapened recently and currently looks cheap relative to history” and thus the bank favors a vega-neutral long 6m30y / short 1y30y swaption straddle calendar spread.

New structured notes

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

• HSBC sold a $50m 19y NC6 zero coupon callable (non-Formosa). The EMTN matures Apr 2042, is callable Apr 2029 and has an estimated IRR of 4.90%. Self-led. Announced Apr 17.

   

• ING Bank is working on a $30m self-led fixed callable maturing Apr 2028 NC2 that pays 5.09%.  EMTN.

   

• Citigroup is working on a $50m self-led fixed callable maturing Apr 2028 NC1 that pays 5.19%.  EMTN.

   

• Santander International Products is working on a self-led fixed callable maturing Apr 2026 NC1 that pays 4.15%. EMTN.

   

• JP Morgan is working on a self-led fixed callable maturing Apr 2026 NC1 that pays 5.125%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing Apr 2027 NC6m that pays 5.25%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing May 2024 NC6m that pays 5.15%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing Oct 2024 callable Jan 2024 that pays 5.15%. Domestic MTN.

   

• JP Morgan is working on a self-led fixed callable maturing Apr 2025 NC1 that pays 5.15%. Domestic MTN.

   

• Barclays is working on a self-led step-up callable maturing May 2043 NC5 that pays 5.05% to May 2028, 5.25% to May 2033, 6.5% to May 2038 and 7% thereafter. GMTN.

   

• UBS is working on a self-led fixed callable maturing Apr 2025 NC6m that pays 5.3%. Domestic MTN.

   

• Royal Bank of Canada is working on a self-led fixed callable maturing Apr 2033 NC2 that pays 5.5%. GMTN.