(Bloomberg) --Bond traders are bracing for the risk of a renewed selloff, driving a surge of trading in options targeting higher yields and prompting investors to unwind long Treasury positions by the most in nearly two years.
The trend gained momentum this week, when there was strong demand for contracts wagering that 10-year yields will breach 4.5%, a level they haven't exceeded since November. Tuesday's flows included a position targeting yields as high as 4.85% while other flows last week included positions targeting 4.55% and 4.60%. The 10-year yield was just over 4.3% late Wednesday.
The positioning comes after the bond market was hit by a fresh round of losses this year after sticky inflation and still strong growth drove traders to dial back estimates for how deeply the Federal Reserve will lower interest rates this year.
In Treasury futures, the latest positioning data shows asset managers unwound net long positions by the biggest amount since March 2022, for the equivalent amount of almost 260,000 10-year futures equivalents, during the week that included Feb. 13's hotter-than-expected January CPI data. Meanwhile open interest data from Friday's session showed front-end short positions building after the producer-price index came in above estimate.
In the cash Treasuries market JPMorgan Chase & Co.'s latest client survey released Wednesday showed all-client net long positions dropped to the lowest since April last year.
Here's a rundown of the latest positioning across the market:
Option Traders Target Higher Yields
The past week has seen large shifts across a number of April 10-year Treasury options, including the 108.00 put and 112.00 call strikes following a huge 50,000 108.00/112.00 downside risk reversal, targeting roughly 4.65% 10-year yield. Other notable shifts on the week were seen in the 109.50 April puts following flows including outright buying in 23,000 at 28 ticks and 50,000 at 31 ticks. On the flip side, heavy liquidation over the week was seen in the 10-year March 111.00 and 110.00 puts.
Asset Managers Cover Longs
The net shift of around 260,000 10-year note equivalents, for a risk weighting equal to $16.2m/DV01 was the largest unwind of long positions since March 2022, according to CFTC data in week up to Feb. 13 which covered the January CPI data.Also over the week, hedge funds covered net short positions by a combined $18m/DV01 from 2-year out to ultra-long futures with most of the net short unwind seen in the 10-year note contract for $6.4m/DV01 in risk.
JPMorgan Clients Cut Longs
The amount of client's outright long dropped 6ppts on the week up to Feb. 20, pushing the net long position to least amount since April 2023. Neutrals continue to climb, now matching most since September 2011, reflecting a lack of conviction about future path of Treasury yields.
Bearish Skew
Matching the activity seen in the options market over the past week, traders continue to pay higher premium for hedging a bond market selloff and higher yields vs. current levels. The premium paid on some of the long-bond put premium may be starting to reflect potential for a cheapest-to-deliver shift in the long-bond futures contract and hedging around such a scenario.
Most Active SOFR Options
Flows over the past week in SOFR options have been focused around adding risk into the 95.00 strike, via structures across Jun24 and Sep24 calls and puts. Flows around the strike included SFRU4 95.00/95.50/95.75/96.25 call condor bought vs selling SFRM5 96.25/97.00/98.50/99.25 call condor. Elsewhere for unwinds, positioning dropped sharply in Mar24 puts following flows related to loss liquidation of ratio strategies.
SOFR Options Heat-Map
Following heavy activity across a number of tenors over the past week, the 95.00 strike has the most populated open interest, where positioning sits at around 1.6 million options over Mar24, Jun24 and Sep24 tenors.
