Quick takes: Swaption volumes by strike Q3 2023

Ali Curi: Hi, everyone, and welcome to ION Markets Quick Takes. I’m Ali Curi, and every week, along with my guests, Amir Khoja 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: Hey, Ali. How you doing?

Ali Curi: Doing great. Chris, why don’t we start with you?
What are your Quick Takes for this week? Which headline from the ClarusFT blog would you like to discuss?

Chris Barnes: So this week, I thought I’d talk about a blog, which is all about swaptions, but I didn’t think I’d talk about what’s in the blog. I thought I’d tell you the story about how the blog got written because Amir and I, whenever we meet people in real life, so many people ask us.

“Why do you write blogs,” and “How would you come up with all of the ideas?” And the swaptions blog is really a classic example of how a Clarus blog actually gets written. First off, I wasn’t a swaptions trader, okay? I traded swaps, but nonlinear products are really a completely different ballgame.

And when I write about swaptions, I try and do it from a very basic level so that it is a very accessible way of looking at our data and I’ve had swaptions on my list of stuff to write about all year, it’s always like, “this week I should write about swaptions” and then something happens, and we and we end up writing about something completely different. Finally started looking at swaptions, it was like 18 months after I last wrote about it in 2022. And I look at the data and the volumes in swaptions have just gone through the roof. They’re like 40 percent higher than we’ve ever seen before. So I’m like, brilliant. What a fantastic time to write all about the swaptions market. When I look at previous blogs I’ve always written about payer swaptions first because rates are going higher.

And then I’ve written about receiver swaptions. And then at the end, there is always a little section on straddles, right? And straddles are a pure volatility play. A combination of a payer and a receiver swaption traded at the same time, at the same strike with the same expiry. And so I wrote this whole blog on how payer swaption volumes have gone up and receiver swaption volumes have gone up.
I was like, the swaption volumes doing so well, this is great. And then I got to the analysis on straddles. And straddles in the data have disappeared. And I was like, what has happened previously in 2022, like 25 percent of volumes were traded as straddles. And then I look at everything I’ve written before and the payer volumes are up by roughly 20 percent and the receiver volumes are up by roughly 20%.

And so that involves going through the data, and we realized as a result of DTCC changes on how you can actually report your swaptions now, people are no longer reporting swaption straddles as a single line. They are now reporting them as two lines, a payer swaption and a receiver swaption, which means that if you just look at the data without knowing this, which is exactly what I did when I started writing the blog, it proves that the swaption volumes look really high this year. But actually, unfortunately, whilst it does look like swaption’s volumes on the whole are higher than in 2022, the truth of it is that when you look at the data, it’s really more a cause of facets of the data than it is of the underlying market.

That’s a classic example, really, of why we are writing blogs every single week. Because if I didn’t write a blog on that, there’s no way for us really to stay on top of the data just from looking at what we are producing each day for that change in swaptions to jump out. So the only way that we can credibly talk about SDR data, incredibly talk about the transparency in the markets is when we are actively using the data week in, week out, day in, day out. And so by actually taking the time and the energy and investing in writing the blog, that then allows me to see, ha, there has been a fundamental change in the data that then informs our priorities for the product itself, we can then go off and spec out what it will actually take to identify straddles in the data and make the 2023 data set on swaptions comparable to all of the data that has gone before. I haven’t really spoken much about what’s actually in the blog there. So I guess I’ll pass over to Amir to see if he’s got any questions on the process, the content, et cetera.

Amir Khwaja: Thanks, Chris. Yeah, interesting. I guess in reading the blog, I guess I was surprised by the range of strikes that trade. All the way I can see from your chart and in the blog from 0. 25 to six point something, right? So there’s strikes, but also the fact that it’s mostly one year is the most active swap tenor. Talk a bit about, were you surprised by the range of strikes compared to historically and the one year.

Chris Barnes: So for me, the range of strikes is not that surprising because of course, I remember swaptions, there’s a lot of novation activity that happens. So these are not all new price forming at market trades that are happening. The trades are being moved from portfolio to portfolio. People obviously have to hedge strikes across a whole raft of legacy trades as well.

And so this chart would look very different if this was just pure new risk transfer activity. You can see that there are the red areas where the heat map is hottest tend to be where the current market values are. So that is not so much of a surprise. I would agree though, that whenever I look at this swaptions data, I’m always surprised how concentrated the activity is.

In one year and 10 year, it seems to be like, those are the real kind of tenors and sweet spots that people are focused on when managing this non linear risk. Five years is third place normally. I can have sympathy with the fact that longer tenors beyond a 10 years, a trickier to trade and obviously a more illiquid difficult from a risk management perspective, but there’s a massive gulf in inactivity from one year to two year, for example.

Amir Khwaja: Thanks Chris. Yeah. And I can see, clearly, the heat maps are great. So a strike axis, a swap straddle axis, we can see the volume in that cell. Did you have a chance to look at, we also have data on premiums. So that would be interesting in future looking at either becoming more or less expensive.

Chris Barnes: Agreed. And to stress the heat maps on the blog, don’t look at expiries either. There’s a lot more analysis that can be done, we are somewhat hampered by presenting data in only two or three dimensions. Mapping the whole surface is achievable with the data as well. And so there are a lot of further chances for our analysis.

We have a couple of dollar swaptions desks who actively use this data, right? Obviously them being live desks, they’re very cagey about how they actually analyze the data and what they use it for, but they are polling us constantly.

Amir Khwaja: And that was surprising to me. I’ve always been surprised by, clearly market makers calibrate of all surface they can make prices on, but when you look at what actually trades very few sparse points on that three dimensional surface of expiry strike tenor trades on a given day, it’s a bit of an art to calibrate the voles away from the money straddles. And always intrigued me is that the Volcubes that people are publishing, comparing those to volume and what’s actually traded is an interesting challenge.

Chris Barnes: Agree. And I’m sure a lot of the FRTB teams, for example, have looked at SDR data to see if their swaption volatility surfaces, whether there are any points which you can argue are not modeled, but are observable. And there was a lot of work looking at the scope of FRTB from that lens as well.

Amir Khwaja: Yeah. So I’m sure, so at the money, swapping both straddles should be modelable, there’s enough data in dollars on those, and back to your point, it’s only by using data and writing blogs, we’re forced to understand the data and that throws up surprises that we have to dig into, and I think that always applies to any data you can’t assume because it’s data, it’s without investigating changes in the regime, right? So it’s unfortunate that some firms are still reporting straddles as one transaction and others are choosing two and it’s becoming a mix. So I guess the rules allow that mix, but it makes it harder for people to use the data as we write on a regular basis. We’re forced to try and understand the data.

And I think that applies to too many of our users that use our data or read our blogs is that helps in understanding that you have to be familiar with the data, changes to the data, what it means, it’s not always telling you what you think it’s telling you. And that’s partly why, I think we we like to write the blogs.

And as you say, as you meet people, they ask you, have you done so and so blog again? So I’m sure you’ve met someone that said you hadn’t done swaptions for a while Chris?

Chris Barnes: Oh yeah. And it really helps with our sales process as well, because normally, as soon as you talk to someone about the data, they really want to know about what it’s showing and what’s new, and if you’re talking about stuff that happened six or seven years ago, it’s just nowhere near as compelling as talking about stuff that’s changing now.

Amir Khwaja: Great. Thanks, Chris.

Chris Barnes: That was everything I had, Ali.

Ali Curi: Chris, thank you so much for that information. And please share with us again the title of your blog post.

Chris Barnes: That was “swaption Volumes by Strike, Third Quarter 2023.”

Ali Curi: Great. That works. Chris, Amir, thank you both for sharing your quick takes. Let’s do it again next week.

Amir Khwaja: Thanks Ali.

Chris Barnes: Thanks Ali.

Ali Curi: 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. Until next week, thank you for joining us.