(Bloomberg) — Traders in the US rates options market are embracing a nascent wager on the Federal Reserve’s interest-rate path: a whopping 3 percentage points worth of cuts in the next nine months.
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Over the past three sessions, positioning in the options market linked to the Secured Overnight Financing Rate shows an increase in bets that stand to benefit if the central bank reduces its key rate to as low as 2.25% by the first quarter of 2025.
Such an outcome — which appears unlikely unless the US economy tumbles into a sudden recession — would mean at least 300 basis points of easing from current levels. This type of wager could be used to hedge another investment.
It’s an aggressive position given that market participants are pricing in some 75 basis points of easing in that period. Fed officials recently forecast just 25 basis points of reductions by the end of this year and a total of 125 basis points by end-2025.
Investors have been scouring economic data and remarks by Fed officials for clues on the exact timing of eventual Fed easing. Now, some are starting to build up bets that hedge tail-risk outcomes, too — such as rapid and extreme rate cuts. Trading in many of these contracts is anonymous, which makes it difficult to identify the firms behind those bets.
In the fed funds market, traders have been ramping up buying of August contracts that would pay out if policymarkers cut at the July 31 policy meeting. Swaps linked to that meeting date, meanwhile, only price in one basis point of a reduction then.
A dovish stance has emerged in the cash market, too, according to JPMorgan Chase & Co. data. The bank’s latest survey of clients showed the biggest net long positions in three months in the week ending June 24.
Here’s a rundown of the latest positioning indicators across the rates market:
JPMorgan Clients Bullish
In the week leading up to June 24, JPMorgan’s all-client survey showed net long positioning rose 1 percentage point to the biggest since March 25. Outright longs are the highest since June 3. The outright short positions were unchanged over the week.
Options Premium Hangs Above Neutral
After premium to hedge a rally in Treasuries rose to highest levels of the year a couple of weeks ago, the skew has drifted back to just above neutral across the curve. Over the past week, open interest has built substantially in the August 111.50 calls — targeting a 10-year yield at around 4.10% ahead of the July 26 expiry. As of Monday’s close, open interest was at 128,524 and roughly twice the size of the second-largest open interest seen in the August 110.00 puts (65,470 options).
Asset Managers Extend Duration Long in Futures
In CFTC data through June 18, asset managers extended their net duration by roughly 141,000 10-year note futures, with overall long duration rising to roughly 7.6 million 10-year note futures equivalents. Hedge funds took the other side, adding around 186,000 10-year note futures to net short duration position. Their extension of net short position in 2-year note futures by $5.6 million per basis point in risk put them at a record net short at over 2 million contracts.
Active SOFR Options
Over the past week the largest positioning add seen in SOFR options have been around the March 2025 calls in the 96.75 and 97.75 strike linked to the dovish call spread wager which has been bought over the past three sessions at a price of 4.75 ticks. Other strikes which have been active on the week include the 94.875 and 94.75 strikes following flows including the Dec25 94.875/94.75 put spread.
SOFR Options Heat Map
In SOFR options out to the Mar25 tenor, the most active strike remains the 96.00 level equivalent to a 4% rate. Large trades involving the strike include the SOFR Mar25 96.00/95.50/95.00 put fly and the SOFR Sep25 96.75/96.00/95.25 put fly. Recent popular trades have also included the SOFR Dec24 96.00/97.00 call spreads which traded back in May.
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