In a 2012 op-ed piece in the Wall Street Journal, Professor Burton Malkiel wrote – “Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today … the 10-year U.S. Treasury note is a sure loser.”
How can investors monitor and manage interest-rate volatility? Futures trading on the CBOE/CBOT 10-year U.S. Treasury Note Volatility Index (VXTYN) is scheduled to launch on Thursday, November 13. The VXTYN Index measures the expected volatility of the price of 10-year Treasury Note futures. The VXTYN futures have a $1,000 multiplier, with final settlement dates generally on a Wednesday, and trading hours from 7:00 am to 3:15 pm Chicago time (except on the final settlement date). Futures on the VXTYN Index will offer customers a way to hedge pure interest rate volatility risk based on U.S. government debt with a single product for the first time.
- BIG MONTHLY MOVES FOR VXTYN SINCE 2003
Rising interest rates can have a negative impact (in the near term) on the market value of bonds and fixed income ETFs, and the implied volatility associated with fixed income ETF options can rise if interest rates are moving.
Both Exhibits 1 and 2 below show months in which the iShares 7-10 Year Treasury Bond ETF (IEF) had big moves. Exhibit 1 shows the six months since February 2003 in which the IEF ETF price dropped by more than 3.1%; in these months the average % change for the VXTYN Index was up 21.7%, as the VXTYN gained more than 57% in two of the six months.
I find it very interesting to compare and contrast the columns in Exhibit 2 to examine the interrelationships of the ETFs and indexes. Big interest rate changes have impacted the IEF and TLT ETF prices. Note that in the table the three biggest moves of the VXTYN – up 64.1%, up 57.4%, and up 38.9% – these moves were bigger than any moves of the VIX Index and all the other indexes in the table.
The correlations of the monthly changes for the VXTYN Index and IEF ETF were –
- Negative 0.16 for all 142 months from February 2003 through October 2014; and Negative 0.37 for the 23 months in which the IEF ETF fell by more than 1.5%.
- The negative correlations and big price moves of the VXTYN Index support the idea of exploring the VXTYN futures for potential for fixed-income portfolio diversification.
Please note that the price movements of the VXTYN futures usually will not exactly match the movements of the VXTYN spot Index. See the VXTYN Futures Primer for more discussion of the pricing of VXTYN futures.
- VXTYN VALUES RANGED FROM 3.62 TO 14.72
- JANET YELLEN, INTEREST RATES, AND FINANCIAL TURBULENCE
A November 7 news story at wsj.com stated that —
“Federal Reserve Chairwoman Janet Yellen said Friday the central bank could trigger some financial turbulence when it starts raising short-term interest rates from near zero, where they have been pinned for six years. The Fed will try to limit such volatility by communicating its interest rate plans clearly, Ms. Yellen said in remarks prepared for delivery at a central banking conference in Paris. …”
- REASONS TO CONSIDER VXTYN FUTURES
The VXTYN Index is calculated by applying the CBOE Volatility Index® (VIX® Index) methodology to futures options data from CME Group’s 10-year U.S. Treasury note contract — one of CME Group’s most actively traded interest rate options products. Three Lead Market Makers (LMMs) have been appointed to make markets in VXTYN futures when the contract launches.
Potential users of VXTYN futures could include mortgage-backed securities investors and other large credit managers seeking to hedge against adverse interest rate movements; large bond funds that are naturally long interest rate volatility and are seeking a yield-enhancing mechanism; and hedge funds, volatility arbitrage firms and global macro participants seeking to express their views on forthcoming monetary policy events or to capture mispricing anomalies between cross-asset volatility (e.g., fixed income versus equity volatility).
- MORE INFORMATION
In future time periods in which interest rates rise and the prices of fixed-income ETFs have steep declines, both the VXTYN Index and the VXTYN futures could have the potential to rise, but we will be able to gain more insights and knowledge on futures pricing after the launch of VXTYN futures on November 13.
For more information on the VXTYN Index and the new VXTYN futures, please visit the VXTYN webpage at www.cboe.com/VXTYN, which has the links below —