March 12, 2020
Implied volatility is telling us something-
Implied volatility is jargon for fear. The higher the volatility, the more likely rates are forecasted to move. For us bond types, the higher implied volatility goes the more uncertain various terminal rate outcomes will be. The below grid depicts changes in implied volatility measures over a 1 month period (2-3 to 3-9 of this year). So when we look at the 1M into 1YR swaption (an option that sets in 1 month and settles into a 1 Yr swap) in the upper left matrix, we see that the expected move in an option that expires in 1M has risen by 37 bps or 93%! On the other hand, a 1Y into 1Yr swaption (an option that expires in a year and settles into a 1Yr swap) in the middle part of the above matrix has actually dropped by 10.9 bps or -18%!
What does this all mean?
Here is our take:
As expected short dated expirations of options on swap futures have risen dramatically. But further out, longer term expiry markets appear to be conflicted. Forward volatilities also imply lower implied volatilities in the future. Volatilities on intermediate vols (greater than 2 year expiration) bifurcate between short rates and long rates (perhaps potential for curve volatility)? Whether it is because the Fed acts (level effects on short term rates) or things are just better, it appears as though implied volatility (either from straight differencing or using a forward flat volatility approach) will subside.
In a nutshell, if the markets are right, this recent volatility shall pass.
Contact Information
Alan Qureshi Managing Partner
aqureshi@bluewater-fintech.com
Travis LaMar
Managing Director, Capital Markets
tlamar@bluewater-fintech.com