I generally don’t like writing about the same topic on consecutive weeks, but in this case, I have to make an exception. Consider how much the Open Interest has increased in the Z contracts since the end of 2017 (highlighted in yellow), since last week’s post. And these do not include Friday’s trading! [The OI data is one day delayed.]
On Friday, 141K EDZ8-Z9 year spread and 128K EDH9-H0 year spread traded. I’m guessing both of these flows are new positions. These are some large volumes – especially in the case of a non-Z year spread like EDH9-H0. Consider that in the past year, the highest volume that EDH8-H9 has traded in a day was 64K, the highest EDM8-M9 has traded in a day was 48K and the highest EDU8-U9 has traded is a day is 38K. So 128K could technically be a “six-sigma” event! LOL [it is not].
I’m curious if that EDH9-H0 was somehow used to hedge some off-sides short position in EDZ8-Z9, or if this is an extension of some of the 2019 hike trades we had been seeing. It may be possible that the EDZ8-Z9 buyer has moved on to EDH9-H0, since Z8-Z9 now has one hike priced in. We also broke the recent high in EDH9-H0 from late October (see the chart on the lower right), so part of the move may have been a technical one. It’ll be interesting to see the OI changes on Monday morning. The OI in EDZ9 is now 100K greater than the SUM(!) of the OI in EDU9 plus EDH0. That’s highly unusual.
The large volumes do make some sense in the context of ten year Treasuries being at 2.66. As mentioned previously. EDZ8-Z9 is not high on an absolute basis – just on a relative one. You could easily make the absolute argument that two hikes should be priced into EDZ8-Z9. But those same advocates would probably say that EDH8-H9 being at 54 is also at least 25bps too low.
An easier way to see the relative pricing is via the butterfly curve. If you take a look at the 6mo butterflies, you can see that the unusually high volumes in EDH9-H0 have caused a large disturbance in the Force. This presents some attractive trading opportunities, depending on your directional view. You can even cover all bases and select structures that will work regardless of whether we rally or sell off.
We need to look at the large positioning in the context of the break of the key 2.63 level in tens. I put out two new bearish trades (Trades H3 and H3b) last week that takes advantage of the development above. We have a lot of dry powder to add on a further move. We want to do to make the most of that dry powder and pick the best trades, depending on whether we think this move will continue. We had an acceleration in the selloff Friday afternoon (when the markets may not have been as liquid). The markets are going to be thin again Sunday night, when the markets reopen. This could provide for some great overnight trading opportunities. In the Trade Thoughts section, I discuss what I think are the optimal plays for next week.