MW Bond-market selloff fuels options-trading frenzy as bets on a rebound surge

By Joseph Adinolfi

Some brave traders see an opportunity to make a quick buck amid the carnage gripping the bond market

Options traders are going bottom-fishing for bonds. It is a risky move, but one that could - with a bit of luck - result in sizable profits. That is, if the past is any guide.

Demand for bullish out-of-the-money call options tied to the iShares 20+ Year Treasury Bond ETF TLT, better known by its handle "TLT," has surged over the past few weeks, according to data from Cboe Global Markets, even as yields on longer-dated Treasurys have marched higher.

If nothing else, the spike in demand for TLT calls is a sign that traders see opportunity amid the latest bond-market meltdown. The yield on the 10-year Treasury note BX:TMUBMUSD10Y was up by 3 basis points at 4.801% on Monday, grazing its highest level since late 2023. Bond yields move inversely with prices, rising as prices fall, and vice versa. Yields on international government bonds have moved higher as well.

The yield on the 30-year bond BX:TMUBMUSD30Y, meanwhile, was up 3 basis points at 4.988% on Monday after it tapped 5% for the first time in more than a year following Friday's blockbuster jobs report. TLT has most of its holdings concentrated in 30-year bonds issued over the past decade.

Rising demand for options that would pay off if bonds rallied has moved so-called skew - which gauges investors' appetite for bullish out-of-the-money options relative to bearish ones - back toward the flat line.

That is unusual. Previously, when bonds sold off over the past few years, skew rose, according to Mandy Xu, head of derivatives-market intelligence at Cboe, who elaborated on this trend in a report shared with MarketWatch on Monday. Skew in TLT options peaked around 3% during bond-market selloffs in late 2023 and 2022, Xu said.

"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," Xu said.

Trading activity in options tied to TLT has exploded over the past few weeks. More than 1,500,000 contracts traded hands on Dec. 19, the day after the Federal Reserve signaled it would likely deliver fewer interest-rate cuts in 2025 than previously expected. That was the highest level on record, according to Dow Jones Market Data.

More than 1,350,000 contracts changed hands on Wednesday, the third-highest volume total on record, according to Dow Jones data.

Demand for calls peaked on Nov. 6, the day after the U.S. presidential election, with more than 850,000 bullish contracts changing hands. It has remained elevated over the past few weeks, with more than 780,000 calls changing hands on Wednesday.

The put-call ratio for TLT, which gauges demand for bearish call options for bullish call options, has remained fairly low recently. It stood at 0.5107 as of Friday, Dow Jones data showed.

Why are traders so eager to try and time the bottom in the bond-market selloff? Bonds have been trapped in a historic bear market over the past few years, with TLT tallying its fourth-straight calendar-year decline in 2024.

Rising yields belie the pockets of opportunity that have at times emerged. Some shrewd traders have capitalized on wild swings in the U.S. bond market over the past couple of years, including in late 2023, the last time yields on longer-dated bonds flirted with 5%.

Back then, TLT dropped by more than 10% between September and October 2023, according to FactSet data. But those losses were followed by sharp gains, with the ETF rising more than 16% in November and December of that year.

Apparently, more tactical players are hoping for a repeat of this dynamic, sensing a near-term peak in yields could be near. The leverage embedded in an option contract would help to magnify any gains.

While TLT prices have trended lower over the long term, "there is lots and lots of volatility within the range itself," Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, told MarketWatch.

Undergirding all of this is the fact that markets rarely move in a straight line.

"If you went long in April of 2024 and took the trade-off in September, you made an excellent trade

Treasury yields have surged since the Federal Reserve announced its first cut to its policy interest-rate target in September. This has resulted in a historically rare pattern where the rise in long-end rates has mirrored the magnitude of the drop in short-term rates. Recently, the climb has been blamed for contributing to the recent weakness in equities.

Wall Street has blamed a number of factors for the move. Popular culprits include a deluge of new bond supply in January, concerns about the sustainability of U.S. deficit spending, and expectations that the U.S. economy could continue to expand at an above-average pace, potentially reviving inflationary pressures. Rising commodity prices have also contributed to upward pressure on yields.

As long-term rates have climbed, short-term rates haven't moved by nearly as much. Expectations that they could remain higher for longer have caused the Fed's estimate of the term premium, a model-derived metric that aims to represent the premium investors are demanding for holding longer-dated bonds, to climb to its highest level in more than a decade, according to Fed data. That has contributed to the meltdown in long-dated bonds and has more recently started to weigh on stocks, strategists said.

On top of all of this is uncertainty surrounding how President-elect Donald Trump's policy agenda will impact markets. Some fear that his plans for tariffs and mass deportations could help rekindle inflation, which would likely push yields even higher.

More immediately, economic reports including the latest readings on the consumer-price index and retail sales are due this week. They could potentially have an outsized impact on the bond market, Goldberg said.

TD started adding more long-dated bonds to its model portfolio last week, Goldberg added. Others on Wall Street have mused about the possibility that now could be a good time to buy, provided this week's data don't feature any surprises.

"Absent major data surprises this week, bond investors are likely to leg back in at higher yield levels," said a team of global macro strategists at Barclays in a report shared with MarketWatch on Monday.

Ken Jimenez contributed reporting

-Joseph Adinolfi

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January 13, 2025 13:13 ET (18:13 GMT)

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