The 10-year Treasury note and 30-year bond suddenly moved to their highest yields in 16 years on Oct. 3. While few could have predicted such a move, a closer look at treasury market volatility reveals a trend of yield expectations moving incrementally higher on the long end of the yield curve over the past few months.
Recent futures and options price action in CME Group Treasury products provide an illustrative case study for using the valuable CVOL tool. CVOL measures 30-day forward looking implied volatility, incorporating every strike price on the implied volatility curve. The inclusion of every strike in the index calculation provides market participants with a representative value of implied volatility levels in each options series, and the simple variance methodology makes the index calculation straightforward and easy to understand.
In addition to calculating 30-day implied volatility, CVOL also generates several other measures, including skew. Skew refers to the idea that different strikes and calls and puts, even on the same underlying and expiration, can trade at different implied volatility levels.
We will use CME Group Micro Treasury Yield futures as a proxy for on-the-run Treasury rates and CVOL in yield terms based on CME’s standard Treasury options in the current paper.
Treasury Volatility Since July
In early July 2022, the 2-year and 10-year U.S. Treasury yields inverted, meaning that the 2-year began yielding a higher rate than the 10-year. This is a closely watched relationship as such inversions have historically predicted an economic recession. This inversion has persisted, and the magnitude of the inversion approached 100 basis points in March 2023 and again in July. Incidentally, the 2-year has also yielded higher rates than the 30-year throughout this time.
On July 28, 2023, the 2s versus 10s inversion traded at a level of -81.5 basis points (and the 2s vs 30s traded at -73.8 basis points).
On that same day, the skew, again in yield terms, of the 2-year began to diverge from that in the 10 and 30-year. The 2-year skew became negative, indicating a put skew while the 10 and 30-year continued to trade with a call skew. In other words, Treasury options traders began pricing the 2-year yield risk to the downside and 10 and 30-year to the upside.
This divergence in skew continued and, in fact, became more pronounced through late September:
During that same time, the difference between the 2-year and 10-year yield declined from 81.5 basis points to just over 50 basis points (and the 2s versus 30s declined to about 42 basis points):
As you can see, based on CVOL skew levels, the options market began pricing in a move toward a “less steep” inversion of the U.S. Treasury Yield curve in late July. Over the next couple of months, the inversion of the 2s/10s and 2s/30s did, in fact, decline by about 30 basis points.
Then on Oct. 3, the 10-year note yield moved above 4.8%, and the 30-year bond moved above 4.9%, reaching those multi-year highs and flattening the yield curve even more.
To be clear, a skew shift will certainly not always predict a price move in the underlying, and there are many dynamics involved in options pricing. For example, sometimes we see an upward move in implied volatility after a period of depressed levels simply because the market might perceive relatively lower levels as an opportunity to buy “cheaper insurance.” However, the scenario described here is a good example of what can be learned from analyzing options pricing, particularly using the CVOL tool.
Of course, the CVOL tool also represents a source for options traders to explore trading opportunities. With both intraday and historical values available, traders can use it to identify short term changes in volatility, skew and convexity, as well as diversions from historical normal levels, similar to what we’ve seen recently in the treasury market.
OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance and economics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.
All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.. In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl). CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).
