Will there be a deep sell-off in the coming weeks? Options traders bet that the 10Y U.S. Treasury yield may rise to 4.75%

The bearish tone is dominating the interest rate options market, indicating that bond traders are preparing for U.S. Treasury yields to soar again in the coming weeks. In the January contract for the 10-year U.S. Treasury bond expiring on December 27, the demand for bearish hedging using U.S. Treasury options has remained stable. In recent days, positions in February options, which will expire on January 24, the week of President-elect Trump's inauguration, have also been steadily increasing.

Between the strike prices of 107.50 - 109.50 for January and February options, open interest or the outstanding positions held by traders has been increasing. This level targets a 10-year U.S. Treasury yield of about 4.45% to 4.75%, while the current yield is around 4.3%. The upper limit of this range would push yields above the 2024 high of about 4.74% reached in April of this year. On Tuesday, a more bearish position emerged in the market, targeting a yield as high as 4.9%, with a premium of $2.5 million. The benchmark 10-year U.S. Treasury yield has not reached such a high level in over a year.

These bets remind investors that, despite the pullback in yields after the election, they are very aware that the so-called Trump trade could gain traction again. For months, the premise of this trade has been that his policies, including increased tariffs, would accelerate inflation and push yields higher. After Trump threatened to impose additional tariffs on U.S. trading partners, U.S. Treasuries fell slightly on Tuesday, and the 10-year Treasury yield rose slightly.

In addition to the first few days after Trump takes office next month, several other factors will be key to these options bets. First, the non-farm payroll data for November, set to be released next week, is expected to show a significant increase in employment compared to the previous month. Then there is the Federal Reserve's policy statement on December 18. Traders see this as a coin toss, deciding whether officials will cut rates by another 25 basis points or hold steady in light of signs of economic recovery.

Meanwhile, a survey by JP Morgan of its clients shows that short positions in the spot market have been increasing, currently at the largest short position in a month The following is an overview of the latest position indicators in the interest rate market:

JP Morgan U.S. Treasury Client Survey

As of the week ending November 25, JP Morgan clients' short positions expanded by 2 percentage points, reaching the highest level since October 28. Neutral positions fell to the lowest level since October 21 this week, while long positions also increased by 2 percentage points.

U.S. Treasury Options Premium Skewed Towards Put Options

In recent trading days, the premium for hedging actions in the bond market has shifted towards favoring put options, as investors seek options for rising yields in the coming weeks. There has been a significant influx of buying in 10-year U.S. Treasury options for January and February, targeting a rise in yields to a high of 4.9%. Tuesday's actions included buying put options for January and February, with a total premium of $5 million for the two trades.

Most Active SOFR Trading Options

In the past week, the market has shown strong demand for price upside protection through various bullish structures around December SOFR options. Notable fund flows include large buyers of the SOFR Dec24 95.625/95.6875 bull call spread strategy, as positions increased, targeting a rate cut by the Federal Reserve at the December policy meeting.

SOFR Hot Picks Chart

Among SOFR options expiring in June 2025, the strike price of 95.50 remains the most popular. Recent flows around this strike price include bullish positions in the SFRZ4 95.50/95.625 bull call spread strategy and the SFRZ4 95.5625/95.50/95.4375/95.375 put condor strategy. The strike price of 96.00 is also quite popular, with a significant number of outstanding call contracts remaining for the December 25 call options at this strike price

CFTC Futures Positioning

CFTC data shows that in the week ending November 19, asset management companies closed out 72,000 equivalent 10-year U.S. Treasury futures, turning to a net long futures position. During the same period, hedge funds closed approximately 257,000 10-year U.S. Treasury futures. In the past week, hedge funds covered about $15.6 million in net short positions per basis point for 2-year, 5-year, and 10-year U.S. Treasury contracts.