Derivatives traders could be positioning for volatility in the bond market before the Federal Reserve’s policy update on Wednesday.
An analyst at Susquehanna International Group noted one options trader had placed large amount of “straddle” derivatives trade in a semiconductor exchange-traded fund at the start of Tuesday.
In a Wednesday note, Christopher Jacobson said the market participant may be bracing for a bout of bond-market volatility as tech shares show vulnerability to the movements of long-term Treasury yields.
As part of a straddle trade, investors are placing a put and a call option at the same time, making a bet the ETF price would make either a sharp move or down before the options expire at the end of this week.
“In terms of potential near-term catalysts that may have been driving the trading, we would point investors to this afternoon’s Fed meeting given the recent volatility in Treasury yields and the tech sector’s sensitivity to such moves,” said Jacobson, though he cautioned it was possible the trade had nothing to do with the Fed.
He noted the ETF in question, the VanEck Vectors Semiconductor ETF SMH,
In the hour after the yield surge, the semiconductor ETF tumbled 2.5%, and later closing down 4.9% at the end of the day.
Rising bond yields raise the discount rate used to value a company’s future cash flows and earnings or the dividend of a stock, lowering the net present value of the asset.
Similarly, investors have been worried the Fed decision could provide another source of volatility for the bond market as the central bank’s unwillingness to enact concrete measures to push back against higher yields have only energized short-sellers.
That volatility could spill over into technology company equities, which have stumbled when long-term government bond yields have risen.
Indeed, the tech-heavy Nasdaq Composite COMP,