May 30, 2018 / 6:02 AM / 5 months ago

RPT-Bets on short-dated Italian debt futures peaked ahead of selloff

(Repeats with no changes to text)

By Abhinav Ramnarayan

LONDON, May 29 (Reuters) - Investor bets on short-dated Italian futures surged close to their highest on record last Friday, data suggested, as investors geared up for a brutal selloff triggered by this weekend’s political developments.

Thomson Reuters data show that open interest on short-dated BTP futures touched its highest in a year on Friday and closed in on record levels, even while the price dropped.

Analysts say this combination indicates that investors are shorting the underlying debt: in this case 2-year Italian bonds.

“Many investors were hedging their positions ahead of the weekend, but I would not exclude that some were taking the opportunity to use this instrument to make some bets against Italy,” said DZ Bank strategist Daniel Lenz.

Since then, a growing political crisis, an impending election and speculation over Italy’s future in the euro zone have triggered a sharp sell off in those bonds.

On Tuesday, they suffered their worst day since 1992 with traders citing risks of a euro zone break-up and redenomination as the main causes.

Questions over a potential collapse in the euro zone usually hit the shortest-dated debt the hardest due to the potential of default and servicing of debts.

Open interest in short Italian BTP futures, which allows investors to hedge their holdings of short-dated Italian government debt, was at its highest in over a year on May 25, at 249,749 contracts, only surpassed by a brief period last year around the French presidential election.

Friday was also the busiest day for the futures contract on record since it was created by Eurex in 2009, with over 257,673 contracts changing hands.

Meanwhile, the price dropped 51 ticks that day to 111.30 from Thursday’s close, normally considered a hefty move, though the dramatic move to 106.43 since then dwarfs that day’s losses.

On long-term BTP futures, open interest had reached an all-time high in early May but it steadily started falling in the day’s leading up to this weekend’s crucial events.

Analysts at Goldman Sachs suggested that given that the actual price of the future fell sharply at the same time, this can’t be a sign of improving sentiment.

“Given the fall in futures prices, we believe that this latest decline in the open interest reflects the unwinding of previous longs rather than new short positions,” the analysts said in a note.

“In other words the recent decline in the open interest reflects a reduction rather increase in net positions on BTP futures by investors.”

SHADES OF CRISIS

In the euro zone debt crisis, many hedge funds and other speculative investors used credit default swaps (CDS), a derivative that provides insurance against losses on debt, to make bets against countries such as Greece.

On occasion, the bets themselves prompted further selling, thereby becoming a self-fulfilling prophecy.

But CDS has become less attractive to speculators as EU regulators introduced rules to prevent investors from buying the derivatives without a corresponding exposure to the underlying debt.

“The BTP futures market has become very important because it’s something which is very liquid and always has very high volumes especially in times of crisis,” said Lenz of DZ Bank.

While some form of futures contract has existed for many year, the current most commonly-used long-term euro-BTP futures contracts were created by Eurex in 2009 and the short-term contract a year later.

Reporting by Abhinav Ramnarayan, Graphic by Ritvik Carvalho Editing by Matthew Mpoke Bigg

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