J.P.Morgan: Sell 1Yx10Y 50bp OTM Receiver Vs. Buying 50bp OTM Payer Swaptions, Delta Hedged

Late on Friday J.P.Morgan noted that “the fact that negative vol.-rate beta is still priced in to skews creates an opportunity to position for an eventual normalization in this correlation. One way to see this is to plot the 1Yx10Y receiver and payer swaption skews for various strikes, versus a reference “empirical skew” that indicates where these skews should be if empirically observed long-run vol-versus-rate betas continue to hold going forward (i.e., the crisis recedes and positive vol-rate betas return).”

• As such, they recommended selling 1Yx10Y 50bp OTM receiver swaptions versus buying 50bp OTM payer swaptions and receiving fixed in the underlying swap to hedge the delta.