Today's positive retailand jobs datais sending stocks soaring this morning. And while equity investors are scrambling to get in on the action, options traders see a dark side to euphoria: higher rates, and sooner than you think.
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"We are seeing quite a bit of options being put on that would profit in a higher rate environment," says Jim Iuorio, Director at TJM Institutional Services. "Most of the trades have a duration of March, April or June...so people are beginning to think that rates will go higher fairly soon," he added.
Only two things can keep interest rates low in the U.S. The first is deflation, and the second would be another round of quantitative easing from the Fed. Since prices are rising, not falling, (Jan. inflation rate was 1.6%) and Bernanke's recent testimony before Congress was about as hawkish as the Federal Reserve chairman's been since assuming that role, these scenarios are looking less and less likely.
Add to that signs that the jobs picture is improving, and you get an options market that's rife with trades hedging against a sudden jump in rates, with traders buying puts on bond prices, and calls on interest rates.
So how are some traders expressing this view?
Mike Khouw, Cantor Fitzgerald's Director of US Equity Derivatives Trading is buying a September 90/85/80 put tree in TLT, an ETF designed to replicate the price of long-dated U.S. Treasuries.
That's a hedge against a 13% move in Treasuries over course of just over six months, which Khouw admits would be a profoundly bearish move.
"I'm putting it on so it serves as a hedge on spike in rates that could negatively impact the equity market," said Khouw, who is also an Options Actioncontributor.
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