(Bloomberg) -- There may be a new eurodollar whale in town. About $30 million has been plowed into an options bet that the market has gone too far in pricing in Federal Reserve cuts this year.
The position has built up over the past week following the Fed’s dovish pivot, and is now likely the largest outstanding in its corner of the interest-rates market. The structure is known as a eurodollar put option condor, and all it will take for it to turn a profit is for the central bank to remain on hold this year.
That flies in the face of what most rates-market participants are bracing for. Traders have ramped up expectations for the Fed to cut this year amid mounting concern about the global growth outlook. Fed funds futures are pricing in about 30 basis points of easing by the end of 2019, suggesting at least one quarter-point reduction.
The options trade grew rapidly Wednesday. Around 200,000 options were purchased in the eurodollar put condor, totaling $20 million. This, together with what had already been bought since Thursday, amounts to an enormous position that’s dominated the surge in risk across eurodollar options expiring in December. On Monday, over 10 million eurodollar futures and options traded, the highest volume this year.
For perspective, the number of contracts traded Wednesday to help build the condor position is equivalent to about half the eurodollar options market’s entire volume on a typical day this year.
Trading Opportunity
To be sure, the trade may be a move to take advantage of opportunities in short-term rates after front-end volatility jumped in recent days. And with almost nine months until expiry, there’s plenty of time to adjust exposure while the Fed remains on hold. The position also stands to benefit from any year-end funding squeezes.
With expiry timed for the Monday after the Fed’s December decision, the position could be the first strong showing of resistance to the market’s dovish swing. The result of Wednesday’s five-year Treasury auction shows this wager may be on to something. Investor appetite seems to be waning for one of the bond market’s hottest maturities of late.
Binky Chadha, a strategist at Deutsche Bank AG (DE:DBKGn), has indicated that the move in yields and rate-cut bets may have its limits.
“In the absence of very negative data or worsening of any of the long list of well known risks, the market is unlikely to take a strong view on further rate cuts,” which argues for a potential rebound in 10-year Treasury yields, he wrote in a note.
