Name That Trade – Speculating on $IYR

by Enis September 12, 2014 12:35 pm • Commentary

Yesterday’s unusual options activity in IYR is particularly interesting given the aggressive selling that we continue to see in the Treasury Bond market today.  To recap, here was the trade from today’s Notable Activity post:

IYR – Aggressive buyer of the Sept20th 72.50 puts, paying 0.33 for 17,889, and then paying $0.44 for 15,313, both in the first hour of the trading session.  This buyer might be anticipating a more hawkish stance by the FOMC in next week’s meeting.  The last significant decline for the REITs sector was after Bernanke’s taper mention in May 2013, after which IYR fell nearly 20% over the next month.

To illustrate what I mean about the selloff in mid-2013, here is the daily chart of the ETF going back 2 years:

IYR daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg
IYR daily chart, 50 day ma in pink, 200 day ma in yellow, courtesy of Bloomberg

The REIT sector’s rally over the past year has still not been able to recoup the full losses that the sector suffered in that very severe one month taper tantrum selloff.

To get a sense for just how closely IYR has followed long-term interest rates, here is the the comparison of the IYR etf vs. the 10 year swap rate in the U.S. in that period:

IYR daily in green, 10 year U.S. swap rate in red, courtesy of Bloomberg
IYR daily in green, 10 year U.S. swap rate in red, courtesy of Bloomberg

The broad moves in that period have been nearly a mirror image of each other.  The recent move higher in rates is the first major scare for IYR since late 2013.

Next week’s FOMC meeting could be a catalyst for the rates market.  Tim Duy noted that the steadily improve data might cause a change in the statement’s language related to the timing of the initial rate hike:

The lackluster August employment report clearly defied expectations (including my own) for a strong number to round out the generally positive pattern of recent data.  That said, one number does not make a trend, and the monthly change in nonfarm payrolls is notoriously volatile.  The underlying pattern of improvement remains in tact, and thus the employment report did not alleviate the need to adjust the Fed’s forward guidance, allow there is a less pressing need to do so at the next meeting.  In any event, the days of the “considerable time” language are numbered.

Put options in IYR are very active again today, already trading over 80k in total vs. the 1 month average of 33k.  Traders are clearly taking precautions in case the bond selloff continues next week.    

Since IYR has already sold off more than 4% this week, we don’t like entering a bearish trade here.  We are looking at the Dec 72/67 put spread if IYR rallies back to near the $74 level, where that put spread would probably be worth around $1.