Image 1: Chart of UK (blue) and U.S. (white) 10-year sovereign yields
The story for 2025 has been the move in sovereign bond yields led by the bond vigilantes as suggested in the Excell with Options report published two weeks ago. This move started last September but has accelerated again early in the new year. At this point, it isn't just about the size and direction of the move, but the absolute level of yields as markets are approaching levels that have led to some stress on governments and financial markets in the past. As seen in this chart, the U.S. and UK yields have been moving in tandem as investors appear to be equally concerned about fiscal largesse and the unsustainability of current budgets. In addition, inflation is also persistent, which is causing problems for central bankers that may be losing their ability to cut rates.
Image 2: Difference between UK Gilt and U.S. Treasury yields compared to the generic front-month BP futures
While the co-movement of UK and U.S. yields has been the same (first image), the difference between these yields, the so-called interest rate differential, does a good job of validating moves in BP futures. In fact, this spread has declined for all of 2024 suggesting the weakness traders have seen. The coming month has a number of catalysts for this spread, with public sector net borrowing in the UK, the nomination hearing for Treasury Secretary Scott Bessent and auctions across the curve in both markets. Any one, if not many, of these catalysts could dictate the direction of the spread and therefore BP futures in the coming month.
Image 3: Relative return of UK FTSE Index and U.S. SPX Index compared to generic front-month BP futures
Capital goes where it's treated the best. This is true not just in the bond markets but in the equity markets as well. For the better part of the last two years, U.S. stocks, as proxied by the SPX, have meaningfully outperformed UK stocks as proxied by the FTSE. The relative return of these two markets has also done a good job of presaging moves in BP futures, with the current long-term relative move in favor of U.S. stocks suggesting more potential downside in the BP futures market. With no particular catalyst to drive the relative equity performance higher, there doesn't seem to be a reason to be bullish BP futures.
Image 4: Daily Ichimoku chart for BP futures
Image 5: Weekly Ichimoku chart for BP futures
This negative outlook for BP futures appears to be seeping into the futures market. The top chart shows the daily Ichimoku Cloud chart and identifies a clear break lower in BP futures. Not only have potential support levels given way, but the cloud itself is turning lower, indicating that bears are taking control of the tape and pointing to lower prices in the future. In the weekly chart on the bottom, the support levels are only now just breaking. The headline futures have broken through the cloud as well as the lagging span from 26 periods prior, which confirms the break lower. While the daily move might suggest this is already long in the tooth, the weekly chart suggests this move may only be beginning. The RSI on neither chart is oversold and the MACD has crossed lower and is moving lower, saying the trends are just beginning. Technically, on either a daily or weekly, the futures are pointing lower.
Image 6: Commitment of Traders for BP futures
Despite this negative look in the future prices, leveraged traders are noticeably not too bothered. In fact, these traders are among the longest they have been over the past five years in BP. This may be surprising to many but suggests an appetite to buy the dip thinking that the daily move may have gone a bit too far and that the interest rate differentials may suggest no particular rationale for lower prices. However, other investors seem to be voting with their feet. The fastest money in the market, most inclined to switch or increase if any of the catalysts in the coming month suggest to do so, are leaning on the long side right now, which may be something I can trade against.
Image 7: CVOL Index vs. BP underlying
Image 8: Skew ratio vs. BP underlying
The positioning report indicates that there is no major concern among individuals and they may even have a contrarian perspective. This is also reflected in the options market. In these charts, I present two views from the CVOL tool put out by CME Group. The top chart is the headline index, which uses all options across the curve to generate a measure of implied volatility. While this measure has gone up in recent weeks to a level of around 12, I can see it's far from the peaks we have seen in 2021 or the Gilt crisis in September of 2022. In fact, while the move in futures prices over the last four months has been large and comparable to the start of the Gilt crisis, traders haven't seen a similar reaction in the volatility market. This isn't just for the headline, either. Traders may see this even more in the skew ratio, which measures the preference for downside over upside options. While there is a preference for downside, as one can tell from the ratio being below one at 0.85, there have been many times over the past five years when there's been more demand for hedging or directional views on the downside of BP. Does this suggest the market thinks the catalysts will be a non-event with little risk premium built into headline volatility? Does it suggest that there's no strong view on whether the catalysts will lean toward the UK or U.S. over this period? More complacent options markets may give the trader an opportunity.
Image 9: Implied volatility surface
While CVOL gives traders a measure of volatility using all options, if one wants to determine which options they might prefer on a relative value basis it's better to use the implied volatility surface that they can find in QuikStrike. The first step is to find the appropriate expirations, and for this I look at expirations that'll take me beyond the catalysts over the next several weeks, so I'm sure to capture them. Then I look at the relative pricing of out of the money puts vs. at the money and out of the money calls vs. at the money. What I see is relatively subdued skew and kurtosis (premium for OTM vs. ATM). The implied volatility surface is very useful for traders to assess how much premium market makers may be pricing in for options before or after catalysts.
Image 10: Expected return for a BP2G5 short 1.22-1.24 call spread vs. long 1.205 put
Putting this information together, there's reason to believe there could be more downside in BP futures. The reason for this may be the moves in Gilts vs. Bonds or FTSE vs. SPX. These moves are confirmed by the moves lower in futures, which have clearly broken down and are trending lower on daily charts and have just broken support (confirmed) on the weekly charts. Positioning in futures via COT is near the longest it's been over the last five years, and the options market pricing suggests more complacency than anything. Looking at CVOL and how it behaves for moves in BP says that both the headline vol index could move higher on a move lower in BP, but that the skew ratio also may move lower, favoring higher volatility for puts vs. calls. The best strategy may be to buy puts but use call spreads to fund the trade. It's still long gamma and it's set at the BP2G5 daily expiration that's set beyond the relevant catalysts. The chart shows the expected return and the breakeven at 1.2034. Below that level, profit goes up on a 1-to-1 basis. Between 1.2050 and 1.22 the risk is the premium spent. The maximum loss is the difference in strikes of the call spread, a risk that may be seen as palatable given positioning is leaning so heavily in favor of BP.
The moves in yields in 2025 hasn't distinguished between the worst offenders, as all bond markets are questioning the sustainability of debt levels. However, as catalysts play out, there may be more scope for relative value and relative performance, which makes the FX market, and BP in particular, an attractive place to look for trade ideas. In this example, I show how the tools provided by CME Group can help identify the possible trade with a Friday Weekly option (there are many FX weekly options to choose from), as well as the specific expiration and strikes to use.
Good luck trading!
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