Options tied to stocks and gold are getting more expensive, even as volatility on major indexes has remain muted throughout the year, according to data from Bloomberg.
Traders say the unusual move comes from how quiet actual market swings have been. The difference between what markets are expected to do and what they’ve actually delivered, the risk premium, has grown, and that is now reflected in the cost of options.
The narrow ranges behind this premium are tied to different drivers in each market. In gold, bets on Federal Reserve rate cuts have been the key force. In oil, the squeeze comes from supply and demand outlooks.
For stocks, it’s been uncertainty over Fed policy, corporate earnings, and unpredictable retail flows. All of it has added up to higher costs for traders looking for protection.
Options grow costly as equities hit record volumes
In equities, options trading hit a record in September, as investors looked to hedge risks around the end of the year. But the willingness to pay for contracts is being capped by the lack of realized volatility.
The S&P 500 Index has been steady, with individual stocks moving in different directions and canceling each other out. That has kept overall index swings restrained.
The result is that the VIX, Wall Street’s so-called fear gauge, has stayed low. But under the surface, single-stock volatility has been climbing as companies prepare to report earnings.
Last week, the gap between the VIX Constituent Volatility Index and the Cboe Volatility Index hit its widest since January, ranking near the highest levels of the last two years. That divergence shows how individual company moves are building up while the broader market remains calm.
Bond investors have played a different game this year. They scored gains by betting on Federal Reserve rate cuts and the slide in short-term US yields. That strategy has paid off, but traders are now shifting to longer maturities on the Treasury curve.
A cluster of bullish trades over the last two weeks has been wagering that the 10-year Treasury yield will drop below 4% for the first time since April.
Pacific Investment Management Co. told clients to lock in yields while they remain attractive. JPMorgan Asset Management and TD Securities both reported clients moving out of short-term paper and into longer-term bonds offering higher yields.
The momentum, which also reflected nerves around the US government shutdown, pushed 10-year yields down 0.05 percentage point in the past week to 4.1%, near the low end of their trading band. The 30-year yield also slid, landing around 4.7%.
Investors push into long bonds as auctions loom
This renewed focus on longer maturities is a reversal from most of the year, when investors made money betting that the spread between short- and long-term yields would widen.
That curve steepener trade performed well, since expectations for Fed cuts drove short-term yields way lower while long-term yields held up, weighed by fiscal and political concerns. Those dynamics helped the bond market deliver its best nine-month stretch in five years through September, Bloomberg data show.
But the trade has since lost steam. Longer-dated bonds have stopped underperforming, and the gap between five-year and 30-year Treasury yields has narrowed to about 1 percentage point. That’s down from 1.26 percentage points in early September, which had been the widest in four years.
The next test of demand will come with the Treasury auctions. The government is preparing to sell $39 billion in 10-year notes and $22 billion in 30-year bonds next week.
Analysts say those sales will show whether the appetite for long-dated paper is strong enough to keep driving yields lower, or whether investors will hesitate after a year of heavy bets on both ends of the curve.
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