(Bloomberg) — Gutsy eurodollar options traders are amassing structures that can make money only if the Federal Reserve’s next move is to cut interest rates by a half-point before the year is out.
CME Group Inc. (NASDAQ:) open-interest data for Thursday — when rising U.S.-China trade tensions and Brexit chaos helped send Treasury yields to 2019 lows — suggest that a wave of new dovish wagers were made in eurodollar mid-curve options. The standout was a $1.25 million play (referencing December 2020 eurodollar futures) that the market will price in a full percentage-point drop in the federal funds target range by the end of next year.
The risk reversal (a call spread financed by selling a put spread) expires Oct. 11, so it’s counting on Federal Open Market Committee meetings in June, July and September for its dovish scenario to play out, and it would take a half-point cut to give the position a chance of making a profit. So far, policy makers are sticking with the view that it’s premature to contemplate any move in rates.
Going by interest-rate swaps, current market expectations are for around 30 basis points of cuts by the end of this year and 65 basis points by the end of next year. Were it to price in the full percentage point, the risk reversal should make a $14.4 million profit, according to Bloomberg’s option scenario analysis.
It’s a high-risk proposition. Even as dovish wagers are gaining in popularity, others in the market are already calling time on them.
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