Goldman: Curve Vol At A Premium; Sell 3m 5s10s Curve Straddles

Goldman Sachs note that “continued macro uncertainty and thin market liquidity has yet again resulted in outsized moves, keeping realized vol., which had seemed to be moderating, elevated. While implied swaption volatility is high in absolute terms, it is (and has been) lower than realized volatility across most of the vol surface. This is not the case in curve options, however, where implied vol is at a premium versus recent levels of delivered vol on short and intermediate curve segments (2s5s and 5s10s). We have discussed some of the fundamental reasons why this might be the case, noting elevated de-correlation risk given large tail scenarios on Fed policy, as well as the dealer community’s short curve vol exposure. However, the 5s10s curve is likely to be somewhat more insulated from the former, and has been notably rangebound in recent months. We expect changes in 5- and 10-Year yields will remain highly correlated in the near-term. Given this, and the relative richness of curve vol, we favor selling unhedged 3m 5s10s curve straddles, noting that the expiry breakeven levels would require the curve to break out of its recent range.”

• They flagged an entry point of 19bp, with a target of 9bp and a stop set at 25bp.