How Is Bond Vol and Gamma This Cheap?

05/08/2015 8:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

Option trader Mark Sebastian, of OptionPit.com, turns to the 10-year Treasury and points out that even with all the movement over the past few days, at-the-money options—though juiced—are probably not pricing in an IV high enough to handle all of this near term realized volatility.

The 10-year made one heck of a nasty move the last few days. This is killing the back end of the curve and long duration treasury funds, the most active of which is TLT. TLT was down more than 2 dollars Wednesday, and is down about 6 dollars in the last 6 days.  Yet, even with all of this movement, ATM options—while juiced—are probably not pricing in an IV high enough to handle all of this near term realized volatility. Right now, I can buy the ATM straddle expiring in 8 days for about 2.85. Less than 1/2 the move the ETF has made in the last 5 days or so.

chart
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Looking at an IV chart, one would think the IV is juiced. This appears to be another example of the pro trader saying "when IV is low all I want to do is sell it and when IV is high all I want to do is buy it." Its counter intuitive, but it is the way most of the pros' think and one of the big differences between trading vol and a physical contract of something.

The Lesson

Unlike stocks and futures, when IV is overpriced, that means it's probably well below its historical mean and closer to its lows. When IV is underpriced, it's probably at or near highs.

The Trade:

I think the move lower might be done and the snap back could be coming. The 121 calls look interesting here. However, if I am wrong, I am going to be really wrong.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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