This week CBOE representatives had several meetings in New York City with representatives of several large financial services firms. Firm representatives told CBOE that many of their clients have expressed increased interest in interest rate volatility over the past few months. CBOE now offers two volatility indexes related to interest rate volatility –
- CBOE/CBOT 10-year U.S. Treasury Note Volatility Index (VXTYN) The VXTYN measures the expected volatility of the price of 10-year Treasury Note futures. The VXTYN Index rose 83% in the period from April 30 through September 12 (see chart below).
- CBOE Interest Rate Swap Volatility Index (SRVX). The SRVX Index first standardized volatility measure in the interest rate swap market.
Futures on options on the VXTYN and SRVX indexes are not yet listed, but some customers have expressed interest in such products.
The Wall Street Journal recently noted that –
“A majority of economists surveyed by The Wall Street Journal—66% of the 47 who responded—expect the Federal Reserve to say at next week’s policy meeting that it will begin cutting back its bond purchases, a widely anticipated milestone in a period of extraordinary monetary policy.” http://on.wsj.com/15UZNo7
THREE CHARTS ON INTEREST RATES AND RELATED VOLATILITY INDEXES AND OPTIONS VOLUME
Below are three charts that show interest rates and related volatility in 2013, and also show the put and call volume for select CBOE options on interest-rate ETFs in 2013. In the period from April 30 to September 12, the VXTYN Index rose from 3.96 to 7.25, and the 10-Year US Treasury Rate rose from 1.67% to 2.91%. In the table below, it is interesting to note that in August the put/call ratio was 0.86 for the TLT options, but was higher than 2.4 for HYG, JNK, LQD, and other options on interest-rate ETFs.
As interest rates rise, the values for many bonds and bond-related ETFs can decline, and since April the prices for the TLT, IEF, HYG, and JNK ETFs all have experienced sharp price declines; price charts for several interest rate ETFs are at www.cboe.com/InterestRateETF
In a March 22, 2012, op-ed piece in the Wall Street Journal, Burton Malikiel wrote —
“Investors with long memories should recall that over the entire period from the 1940s until 1980, bonds were a horrible place to be. Given the likely trends, U.S. Treasurys and high quality bonds are likely to be extremely poor investments and are very risky.”
For investors who want to manage the risk of their fixed income portfolios, options on interest-rate ETFs can be valuable risk-management tools, and the VXTYN and SRVX indexes can be helpful real-time gauges of expectations of future interest rate volatility.
As an example, let’s suppose an investor owns the ETF known as the iShares Lehman 20+Year Treasury Bond Fund (TLT), and the investor is concerned about the possibility that the TLT ETF could continue to decline in value due to rising interest rates. One possible solution could be to do an outright sale of the TLT ETF. However, instead of a sale of the TLT, the investor also could explore the pros and cons of holding the TLT ETF, and also using options strategies such as (1) selling TLT covered call options to generate extra income, and (2) buying protective puts on TLT in order to reduce principal risk. Information on many options strategies is at www.cboe.com/Strategies.