Merrill Lynch’s MOVE Index, which captures option volatility for 1-month options on all On-The-Run Treasuries across the maturity spectrum, increased significantly as bond yields declined. As you would have guessed, today’s move signals a new regime of interest rates characterized by heightened uncertainty as market participants bid up the price for options to hedge their current risk exposure. The main players in this space can range from, but not limited to banks, hedge funds, institutional players, and mortgage originators.
The MOVE Index advanced 20.9 points to 116.7, for an increase of 21.8 percent in one day as Treasury yields declined as much as 18 basis points. In the past five years, there have been only 5 days (including today) where the index spiked by more than 20 percent. Here we will examine what kind of move in the Treasury market led to a spike in the MOVE and what happened the day after.
Unlike its equity counterpart, the CBOE’s VIX, the MOVE can spike as the underlying (in this case Treasuries and the VIX has the S&P 500) moves in either direction. The VIX usually spikes as stocks go down. Hence, the jumps in the MOVE Index is fairly agnostic and can be a result of yields moving in any direction.
The chart illustrates the last 5 years of the MOVE index with the aforementioned 20% increases highlighted (the first circle in June 2007 contains two episodes).
Merrill Lynch’s MOVE Index 5-Year Chart
On June 7, 2007, the MOVE index spiked 20.2 percent as the yield on the 10 Year Treasury increased 17 basis points that day. On the following day, the yield on the 10-Year declined 3 basis points.
On June 14, 2007, the MOVE index gained 22.6 percent as the yield on the 10-Year increased 14 basis points. On the following day, the yield declined 9 basis points.
On August 8, 2007, the MOVE index gained 27.6 percent as the yield on the 10-Year declined 11 basis points. On the following day, the yield increased 4 basis points.
On September 15, 2008, the MOVE index advanced 27.8 percent as the yield on the 10-Year declined 33 basis points. On the following day, the yield increased 5 basis points.
Apparently a massive change in yields that translates to a sizable increase in option volatility equates to a reversal the following day. The reversal is a fraction of the initial move and can probably be characterized as a respite. As with any historical analysis, I am sure there can be other variables that could extend the price/yield changes the following day to a point where there is no respite. However at some point, short covering occurs, exhaustion set in, and a slight reversal eventually takes place.
In any event, a signal in the MOVE represent a change in investor sentiment as rates settle in a new yield environment. As long as news across the Atlantic hit news wire, then its safe to assume that this flight to quality trade will persist. Though, based off of this analysis, we should see a reversal tomorrow as yields increase slightly.