Differing developments in volatilities on the interest rate market: an opportunity

The escalating US trade war has dominated the headlines in recent weeks. This is also overshadowing what is actually a healthy economic situation in most countries. Protectionism threatens economic growth. Central banks are now also taking a critical view and are increasingly deviating from their course of scaling back expansionary monetary policy, as the latest statements by Powell and Draghi show.

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The current market environment

The escalating US trade war has dominated the headlines in recent weeks. This is also overshadowing what is actually a healthy economic situation in most countries. Protectionism threatens economic growth. Central banks are now also taking a critical view and are increasingly deviating from their course of scaling back expansionary monetary policy, as the latest statements by Powell and Draghi show.

America versus Europe

In recent years, volatilities driven by central banks‘ fiscal policies have been fairly low in absolute terms and also largely in sync globally. In recent days, however, an interesting development has emerged: In contrast to German Bunds, the implied volatilities of US Treasuries have risen significantly. This is shown in the chart below. There is great uncertainty about the Fed’s future course. More and more market participants now expect an interest rate cut. However, the Fed is not yet entirely convinced that it will deviate from its chosen course due to Trump’s policies. This interesting market environment opens up a good opportunity for returns.


Fig. 1 | Implied Volatility (1 month, at-the-money, US Treasury Future vs. Bund Future)

Source: 7orca Asset Management AG, Bloomberg (01.01.2014 -06.06.2019)

Implications for the 7orca Vega Return Strategy

In the short term, this development has cost performance in the Treasury Future. In addition to mark-to-market losses in the course of valuation due to increased implied volatilities, calls have run into the money. For new option contracts, there is the possibility that 7orca can use the increased volatility level for attractive premium income. This is also reflected in the dynamic exposure management. The exposure is currently at a maximum for Treasury options and remains low for Bund options. The portfolio management is therefore taking advantage of the opportunity offered by the recent interest rate development.

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Author

Deputy Head of Portfolio Management

Tom Pansegrau, CFA

Tom Pansegrau is responsible for the management of 7orca's volatility strategies and the development of risk premium strategies. He has more than 10 years of professional experience in quantitative asset management and has worked for Robeco, Metzler and Berenberg, among others. Previously, he managed options-based investment solutions at Berenberg as Head of Liquid Alternatives. Tom Pansegrau holds a Master in Finance (Financial Engineering, M.Sc.) from the University of Lausanne and is a CFA Charterholder.
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Disclaimer

The investment strategy presented in this document is aimed exclusively at professional clients within the meaning of the German Securities Trading Act (WpHG) and can only be implemented for these clients (typically in a fund structure). All assumptions, forecasts and information are based on the standardised design of the 7orca Vega Return Strategy, which was implemented at average market costs.

Further information on this standard investment process can be found in the generic RfP, which is available on request from 7orca Asset Management AG. Due to the different investor needs and situations and the resulting specific pricing, further individual costs for management and custody are not taken into account. However, 7orca Asset Management AG will be happy to provide you with a specific offer that takes into account your individual needs and conditions. Past performance is not a reliable indicator of future results. All information in this document has been compiled to the best of our knowledge and belief on the basis of the data available to us. However, no liability under civil law can be assumed in this respect. References to specific financial instruments are purely exemplary and are in no way to be understood as a recommendation in the sense of investment advice. A publication of 7ora Asset Management AG.

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