Zhitong Finance learned that traders are closely watching this week's US inflation data to find the possibility of breaking the calm in the market. According to Citi's data, according to the day's affordable interperiod trading price, the options market is betting that the S&P 500 index will fluctuate 0.9% after the release of the CPI report on Wednesday. Traders will pay close attention to this report to find signs of how much the Federal Reserve will cut interest rates this year.

At a time when the CPI report may cause large fluctuations in the US stock market, market volatility has been suppressed. The VIX Index, which measures volatility, is close to a low point during the year, while the volatility of VIX options used to hedge against sharp market sell-offs is the lowest in 9 years. Meanwhile, since the Federal Reserve announced its interest rate decision on May 1, the US Treasury bond market has been betting on cutting interest rates more drastically.

The overall market predicts that the CPI fluctuation after the announcement of this week will be the same magnitude as the day after Nvidia (NVDA.US) announced results. The implicit fluctuation between these two was greater than the forecast after the US government released the next non-farm payroll report on June 7; despite the “collapse” of the non-farm payrolls accident in April — employers cut recruitment scales, indicating that the labor market is cooling down after strong performance at the beginning of the year.

Stuart Kaiser, head of US stock trading strategy at Citibank, said on the phone: “Inflation has been a bigger event for traders over the past two years, and it still is. Although recent employment data falls short of expectations, investors will generally be satisfied with any data showing more than 150,000 new jobs in the month, as this still reflects a strong labor market. If employment growth falls below this level, the market will begin to turn its attention to job growth rather than inflation.”

Overall, lower volatility and lower put option premiums have made overall stock market hedging more attractive, and there were some VIX bullish spread purchases last week. Tanvir Sandhu, chief global derivatives strategist at Bloomberg, stated, “Higher interest rates have boosted S&P forward contracts, and the premium of call options over put options has also increased. This facilitates the 'collar' strategy of selling call options and buying call options. The decline in the bias of the S&P 500 index (close to the low point in the past 10 years) has also reduced the cost of this strategy.”

The US Treasury bond market positions before the inflation report was released seem to have been neutralized, as the market has made up short positions and established new long positions since the Federal Reserve announced the interest rate decision and the April non-farm payrolls report was released. Shortly after the Federal Reserve announced its interest rate decision, SOFR futures showed clear shortfall recovery, because Federal Reserve Chairman Powell seemed to have eliminated the tail risk of interest rate hikes becoming the next policy move, so bulls began to form. Recent options show that end-of-line risk hedging has moved to a more aggressive path of interest rate cuts, and some SOFR options positions are even focused on the possibility of interest rate cuts as early as July.

Late last week, a large-scale risk reversal transaction was carried out for options due on May 24 — if the yield on 10-year US Treasury bonds (currently around 4.5%) falls to 4.25% before May 24, then this low-cost position will profit about $15 million. However, if the 10-year Treasury yield rises to around 4.7%, it could also lose up to $15 million. The analysis shows that if the 10-year US Treasury yield falls below 4.35%, the position will start to make money. If the yield is higher than 4.58%, the position will lose money, but once it exceeds this level, profits or losses will quickly accumulate.

There are several possible motivations for traders to make this kind of trade. If linked to the base position of US bond futures, this may be a cheap hedge against the rise caused by April CPI and retail sales data. This could also be a bet on implied volatility, where an increase in implied volatility will drive up the price of the option. In any case, holders of this strategy should be able to mitigate losses by making adjustments or exiting positions when yields begin to climb.