8/6/2019 Short Gamma

1/1

Trade Idea : Short gamma at the front end of the curve

Trade: Sell 100MM 6Mx2Y swaption straddles (atmf, strike = 3.57%)

Buy 67MM 1Yx2Y swaption straddles (atmf, strike = 3.86%)

The trade is vega neutral and should be actively delta hedged

Why do the Trade:

1) During a Fed pause shorter term rates tend to become more stable and delivered volatility

tends to drop. Chart 1 shows the 2-month delivered vol on 2Y swap rates during the first Fed

pauses averaged over the last 2 easing cycles. Dates used: 12/11/01, 11/17/98

2) During a Fed pause, uncertainty about the Feds actions get pushed out and implied vol for

longer expiries increases relative to shorter ones. Chart 2 shows the implied vol spread between

1Yx2Y and 6Mx2Y during the first Fed pauses averaged over the last 2 easing cycles. Dates

used: 12/11/01, 11/17/98

Chart 1

2-month delivered volatility on 2 year swap rates

4

5

6

7

8

9

10

11

0 25 50 75 100 125 150

Days following a Fed pause

bp/day

Current 2-month delivered vol

2-month delivered vol on 2Y yields during the first Fed

pause averaged over the last 2 easing cycles

Chart 2Implied Vol Spread

-0.3

-0.1

0.1

0.3

0.5

0 10 20 30 40 50 60

Days following a Fed pause

bp/d

1Yx2Y- 6Mx2Y