Deutsche Bank, Schroder Salomon Smith Barney and UBS Warburg are pitching swaption trades that take advantage of the high levels of volatility across the swaps curve in Europe and the U.S. Deutsche Bank is recommending selling euro and U.S. swaptions, in which the investor pays fixed and receives floating. This is because the forward curve is predicting higher rates, while Deutsche Bank predicts rates will remain low, according to George Cooper, global fixed income strategist in London. Specifically, the firm is recommending selling a one-year option to enter five-year swaps or five-year options to enter five-year swaps in both the euro and U.S.
Rory Byrne, European fixed income strategist at Schroder Salomon Smith Barney in London, explained that the firm is looking at the short-end of the swaps curve, but is not directional. The trade involves selling a six-month straddle on a one-year swap. The investor sells an out-of the-money swaption, paying fixed and receiving floating, and at the same time, sells an in-the-money swaption, receiving fixed and paying floating. Implied volatility is trading at 3.6% currently, and the strike on the trade is 4%. Investors receive 0.5% of the notional value for this trade.
UBS Warburg, however, is pitching a trade that is long volatility, in which the investor buys a one-year option on a two-year swap, receiving fixed and paying floating. This is because volatility is becoming increasingly linked to the level of rates, said Meyrick Chapman, derivatives strategist in London, explaining that as rates have fallen, implied vol has risen because investors look to get out of the equity markets and purchase swaptions. He expects implied vol will rise further as there could be more rate cuts from the European Central Bank as growth in Europe remains subdued.
