Quick Takes: Swaption volumes by strike Q2 2024
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Ali Curi: Hi, everyone, and welcome to ION Markets Quick Takes. I'm Ali Curi, and every week, along with my guests, Amir Khwaja and Chris Barnes, we take a Quick Dive into the headlines on the Clarus blog. Let's get started. Hi, Amir. Hi, Chris. 

Amir Khwaja: Hi, Ali. 

Chris Barnes: Hi, Ali. How are you doing?

Ali Curi: I'm doing great. Welcome back to Quick Takes.

Chris, let's start with you. What's your Quick Take for this week? Which headline from the ClarusFT blog would you like to discuss?

Amir Khwaja: All right, Ali this week I'm gonna try and talk about swaptions. And I have to admit that every time I try and talk about swaptions, I feel as if I'm on like rocky ground.

I know that on the blog and the podcast we like to cover like geeky topics, but like every time you ever meet a swaptions trader, it's like an intellectual battle, they are trying to prove to you that they know more. And so I always try and write these blogs from kind of a humble opinion. I guess? I've never traded swaptions. I've never been an options trader, but I was active enough in the market to know what a swaption is, roughly how the market trades. So I don't try and be super geeky on this. I try and keep it like a high level and I have to admit every time I write a blog on swaptions, it does get positive feedback from the readers.

I think it's serving a purpose. It might also speak to the fact that swaptions traders are not very approachable. And so people really want to read our stuff. Who knows? But from a high level, what this is basically looking at swaptions data that is reported by US persons to the US SDRs. So we're mainly looking at volumes.

This is probably fourth or fifth blog of this type I've written on swaptions. In the past, I've always written about swaptions when there's been a massive move in rates, it's a bit like a checklist for us. When there's volatility in the markets, when there's big moves, we write a blog about the massive volumes in clearing the massive volumes in dollar swaps and Euro swaps, and then when there's a big bout of volatility or event risk, I tend to write about cross currency swaps.

And then the third one is swaptions. It's been volatile. Swaptions are a way of trading volatility itself. What has happened to two volumes. We don't make these like a regular series. They tend to be ad hoc, but in 2024, I've tried to make it more regular. So I first wrote about it Q1 for 2024. This one covers activity of swaptions in the dollar market by strike for Q2 of 2024.

I think there's some interesting things that come out of it, both on the data side and on the market side as well. I'm just going to do a whistle stop tour of the content of the blog. I think number one is to talk about the data. About two years ago, there was a rewrite of what people had to report for swaptions.

That changed two things. One is that packages of swaptions are now just generically called packages. Whereas before there was a carve out for the reporting whereby a specific package, which is called a "straddle" would actually be reported at the time of trading as a straddle. That is no longer the case.

And that is why we see a higher number of swaptions reported than previously. So what Clarus have done is looked at the logic of what a straddle is. For our listeners, I will explain. So straddle is a combination of a receiver swaption and a payer swaption with the exact same expiry. The same underlying and the same strike.

So that basically means if rates don't move, then both the payer and the receiver positions expire worthless. And you either gain the premium or lose the premium paid, depending on whether you're buying or selling the straddle. So it's a pure volatility play. What I didn't realize is that now that we identify straddles at Clarus, and now that we know which SEF has executed the straddle.

We can then go in and look at the difference between dealer to client SEFs and dealer to dealer SEFs. And what we find is about 80 or 85 percent of volumes traded on D2D CEFs are actually in straddles. So straddles are a way for dealers to basically create this standardized product to put liquidity on standardized strikes in standardized products, to be able to trade pure volatility packages in the dealer to dealer market.

That's something that I wasn't aware of before I wrote these blogs. I think it's really nice how we can go through this systematic identification of packages. And using the combination of identifying trades and the platforms to explain market structure as well. So it's a really nice presentation of the data and how, whilst the data, when you look at swaptions, looks messy, difficult to interpret.

If you have someone like me, who's au fait with the markets. It can give the data some real structure. Talking of structure, we've also changed from reporting payers and receivers for swaptions, so that all options are now puts or calls. So it's standardized across rates options and FX options. I must admit, I think there are a couple of platforms out there who have maybe got confused between payers and receivers and puts and calls.

So if you have a look at the blog, we've put some examples out. But it does look like there might be some, let's say, "misreported" swaptions out there. So that's something else for readers and listeners to be aware of. Finally, I want to highlight how we present the data. And we present the data naturally as a heat map.

So a heat map basically has a number of tenors and a number of strikes. So strikes are along the top of your grid, tenors along the left hand side. And we color code each of the cells depending on how much volume has traded. So from green or cold into red, which is really active. Those active strikes tend to always be around the current at the money swap rates, but we can now monitor quarterly, where those at the money strikes are, and also where the hot areas of that heat map are.

And I think one thing that's really interesting for this is when we do that, we can see a structural imbalance in the swaptions market. And what I mean by that is that if you look at activity in 20 year tenors, so any swaption, irrespective of when it expires, if it's got a 20 year tail, a 20 year underlying, the chances are really high that 20 year is a receiver.

There seems to be very little activity in straddles and in payers, and all of the activity related to 20 year tails are in receiver swaptions. We don't see that for any other underlying, the volumes are meaningful. It's not like an odd trade, and I've seen this in Q3 of '23, Q1 of '24, and Q2 of '24. It seems to be a real feature of the market. Keep on asking our readers to tell me why. I have no idea. 

But it's definitely something that comes out in the data. This is a complex topic, right? It's difficult to do swaptions justice in a short podcast. Amir, you've read a whole series of these blogs now. Any particular questions from you on either swaptions market or content of this blog?

Sure, Chris. Yeah, thanks. I guess a swaption strike volume heat, is one of the most obvious, a nice heat map type views, right? And so I think that works extremely well in your blogs. I like your point about the CFTC rewrite a few years ago. While that made things much simpler, and new fields turned up like the mid cut of the SEF. Unfortunately, it has caused confusion getting from payers receivers to puts and calls, right? 

Chris Barnes: Agreed. 

Amir Khwaja: We're still waiting for some of that data to be fixed because naturally, swaption desks and swaption systems enter payers receivers straddles, not puts and calls. And so that's unfortunate, and it's still not been fixed for some sets, years after the first reporting change, which is unfortunate.

But I think, each time, there's a change in reporting data, there's improvements, and there's some things go backwards, right? So I expect that should get fixed. Again, I think I've made a comment before, it always surprises me, the range of strikes that trade in pairs receivers. There's some really 6. 75. 

Chris Barnes: It strikes from 0 percent to 7%, like every single quarter. 

Amir Khwaja: Yes. 

Chris Barnes: The range of strikes is really phenomenal. 

Amir Khwaja: But as you say, the volume is heavily dominated around the money forward at that time. 

Chris Barnes: Correct. 

Amir Khwaja: And it goes to be nice to see, there's been big rate changes in the last week or so.

So what's going to happen in Q3 in the swaption market, would be interesting. 

Chris Barnes: Yeah. It's always the way, as soon as you write the blog and you go "Markets have not been that volatile really," and the week it's published and the week the podcast comes out, we see historic moves in rates and it's, oh, the one other thing we've never done, I think for swaptions is done a mechanics and definitions type of walkthrough.

I think that's mainly on me, I'm still getting comfortable writing commentary about options markets. I'm sure that will come with time. 

Ali, I think that's everything we had time for today. So I'll hand back over to you. 

Ali Curi: Great. Thank you, Chris. And please share with us again, the title of your blog post.

Chris Barnes: Yeah I'm not very happy with the title. So if you just search for "Swaptions, Clarus," it'll probably be better. The actual title is "Swaption volumes by strike Q2 2024." 

Ali Curi: All right, great. That works. Amir Khwaja, Chris Barnes, thank you both for sharing your Quick Takes. Let's do it again next week. 

Amir Khwaja: Thanks, Ali.

Chris Barnes: Thanks Ali. See you next week.

And that's our episode for today. You can read more about these topics on the Clarus blog and you can follow ION Markets on X and on LinkedIn. Thank you for joining us.