TLT Options Signal No Fear as Yields Spike Higher

Link to Report: Macro Volatility Digest

WHAT STANDS OUT:

• US yields continued their climb higher last week on the back of robust economic data, with the market now expecting just one more Fed rate cut this year (down from 1.75 just a week ago). Despite the large sell-off in bonds, what stands out is how remarkably calm sentiment has been in the options market this time around.
• Unlike the previous two times when yields spiked and TLT fell more than 9% in a month (Oct’23 and Oct’22), this time we’re seeing very little demand for protection in long-dated bonds. In fact, TLT 3M skew has actually flattened in recent weeks on upside call buying and is now trading ~flat vs a high of 3% in the two previous sell-offs (see chart below). In other words, traders are currently pricing roughly equal chance of yields being lower vs. higher in the next 3 months and are using options to fade this move. This comes as TLT option volumes have exploded higher. Over 1.35M contracts traded last Wednesday – 3^rd highest volume day on record.
• As inflation risk has returned, equity/rates correlation has turned back to negative (i.e. bonds no longer effective as a hedge to equities), with the 1M rolling correlation between the SPX® index and the 10Y yield falling from a high of +44% post-election to -34% currently.

Chart: No Demand for Protection in Long-Dated Bonds

^{Source: Cboe}

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