Treasury Trends

Where do people go to manage Treasury risk during times of market stress and elevated volatility?

In recent months (and years), fixed income traders have increasingly turned to options on Treasury futures to hedge the volatility of the Treasury markets. Options on 10-Year Treasury Note futures have been a key tool to manage this risk.

Options on 10-Year Note futures are deep, resilient pools of liquidity, as shown by the strong, growing levels of volume and open interest during these times of market stress. During the first quarter of 2020, 10-Year Note options had an average daily volume (ADV) of more than 700,000 with an average daily open interest (ADOI) of more than 4.36 million contracts. In order to put this into perspective, options on 10-Year Note futures had an ADV of more than 500,000 (+37%) and ADOI of 3.56 million (+23%) in 2019.

Managing Treasury volatility risk is one of the many reasons some customers have used options on Treasury futures. A discussion of the recent trends in Treasury volatility is below.

Exhibit 1: Options on 10-Year Treasury Note futures – Daily volume and open interest

Rolling 20-Day moving averages, January 2010- March 2020

Realized and implied volatilities of 10-Year Treasury Notes

The recent trends in realized/historical and implied volatilities of 10-Year Treasury Note futures and options are a good example of how our Treasury futures and options markets work in tandem during times of market stress as in recent weeks.

A month ago, on March 24, the difference between the realized (20-day) and implied volatility of 10-Year Treasury Note futures and options was staggering.  Implied volatility for options on June 2020 futures was 7.06% and realized volatility for June 2020 futures stood at 14.32%.

Over the next two weeks, from March 24 through April 6, implied volatility of options on June 2020 futures fell to 5.1%. Meanwhile, realized volatility fell to 12.02%.

Over the next three weeks, April 6 through April 24, implied volatility ranged between 5% and 6%. Realized volatility continued to fall, dropping to 10.92% on April 13. And it fell further to 5.07% on April 20.

Implied volatility stood at 5.46% on April 20.  For the first time in recent history, realized volatility was lower than implied volatility.  For the remainder of the week of April 20, realized volatility continued to be slightly below implied volatility.

The converging of realized and implied volatilities demonstrates a return to normalcy for Treasury futures and options. The similarity of realized and implied volatility suggests that the price volatility of 10-Year Note futures is expected to continue to stabilize in the coming weeks.

Please refer to Exhibit 2 below for the one-month histories of realized and implied volatilities for 10-Year Treasury Note futures and options.

Exhibit 2: Options on 10-Yr. Note futures – Realized and implied volatilities

June 2020 contract, 24 March 2020 through 24 April 2020

To analyze and compare volatilities of CME Group products, check out the QuikVol® Tool.

Treasury market participants can also use Treasury futures and options to hedge exposure to new Treasury issuance. The following section explores how the rising budget deficit will lead to increasing Treasury issuance.

Treasury Issuance

In FY2019, the Congressional Budget Office (CBO) reported a budget deficit of $986B, and the US Treasury produced net Treasury issuance of $1.04T. As of 24 April 2020, the CBO is projecting a budget deficit of $3.7T for FY2020. Through the first two quarters of FY2020, net Treasury issuance will be $807B. Applying the CBO projection, Treasury net issuance is likely to increase significantly over the next two quarters, Q3 and Q4 2020, increasing the need to hedge with Treasury futures and options.

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