Feb 7 U.S. bond prices have stabilized this week after a sharp sell-off, but signals in the options market show traders expect prices will fall further, putting upward pressure on long-term interest rates.
The level of open interest in put contracts on U.S. Treasuries futures and exchange-traded funds that track Treasuries shot up in the first six weeks of the year, as the yield on U.S. 10-year government notes rose above 2 percent to the highest level in nine months.
The 10-year Treasury yield is a benchmark rate that influences rates on U.S. mortgages and other consumer loans.
It is still early to determine whether the bond market sell-off will be sustained or will fizzle by spring as happened in the previous two years.
A recent rise in put activity in the bond market suggests some traders anticipate bond prices will resume their decline, especially if investors favor stocks and higher-returning investments than U.S. federal debt on optimism the economy will pick up steam later this year while the Federal Reserve keeps short-term rates low.
"The market is still quite split on which direction rates will move in next, which has led quite a few people to hedge against higher rates in the options markets," said Gennadiy Goldberg, an interest rate strategist with TD Securities in New York.
Significant activity in the ETFs has been in the iShares Barclays 20+ Year Treasury Bond fund, which on a daily basis is one of the more actively traded bond-focused ETFs, averaging 5.2 million shares in the last 50 days.
Open interest in the March $116 strike puts has jumped in recent days, from about 5,000 on Jan. 30 to 114,764 contracts on Thursday morning, the largest in the product, according to options analytics firm Trade Alert. Open positions in the February $120 puts, expiring on Feb. 15, stood at 56,596 lots.
Investors often use equity puts, allowing them to sell the shares of a security at a fixed price any time up until expiration, to guard against downside risk. When the TLT loses value, bond prices are falling and yields are rising.
Put spread bets seen in the TLT earlier this week could have been traders hedging their February positions into March by purchasing the March $116 strike put against the sale of the February $120 strike put.
MORE BETS ON BONDS FALLING
The U.S. Treasuries futures market is also indicating more bets that bond prices will fall, with the current put-call ratio soaring since the beginning of the year.
On a 30-day moving average basis, the ratio on 10-year Treasury futures has jumped to about 5.5, a record high, from 4.5 six weeks ago. Still, with some expecting rates to go lower, it is leading to "somewhat more whiplash-like price action in yields as some are jumping in to buy dips while others reload shorts on rallies," Goldberg said.
In the TLT, the February-March put spread first started trading on Jan. 30 and resurfaced again on Monday and Tuesday.
For example, an investor on Tuesday sold 22,000 February $120 TLT strike puts at $3.80 and bought 26,000 March $116 strike puts for $2.19 per contract, said WhatsTrading.com options strategist Frederic Ruffy.
Data from options research firm Schaeffer's Investment Research show big block purchases on Jan. 15 and 16 of February $120 strike puts, a bearish position that worked as TLT shares declined 3.5 percent from Jan. 15 to Tuesday's close.
By rolling into March, the trader "appears to be expecting a continued decline in Treasury prices and an increase in yields during the next six and a half weeks," said Joe Bell, senior equity analyst at Schaeffer's Investment Research.
However, Enis Taner, global macro editor of options analytics firm RiskReversal.com, believes the trade is being done as a protective move by an investor already long Treasuries in one form or another, not someone "expressing a speculative short view on TLT."
TLT shares rose 0.39 percent to $117.39 near midday on Thursday.