*

Options market braces for biggest post-election swings in

30

years

*

Republican sweep could lead to higher tariffs, interest

rates,

and Treasury yields

*

Democratic win may result in higher taxes, disinflation,

and

potential Fed easing

*

Rate volatility has been higher than that in the stock

market

By Gertrude Chavez-Dreyfuss

NEW YORK, Oct 29 (Reuters) - Ahead of the U.S.

presidential election next week, investors in interest rate

options are putting on trades that will pay off if rates remain

elevated, suggesting that the market is pricing in a sweep by

the Republican party.

The options market is also bracing for the biggest

post-election swings in U.S. Treasury yields in more than 30

years.

If Republicans take both houses of Congress and the U.S.

presidency, it likely would bring higher tariffs, and

consequently higher interest rates, especially at the back end

of the yield curve, due to inflation. Increased U.S. Treasury

debt supply to finance a huge fiscal deficit also lifts

longer-end yields.

Investors have been buying so-called long-dated payer

swaptions, a trade where investors buy the right to pay a fixed

rate and receive a floating one, benefiting when interest rates

remain high.

"The options market is behaving as if it's expecting a

higher probability of a Republican sweep," said Amrut Nashikkar,

managing director, fixed income strategy, at Barclays. "This

price action is what you would expect: rates moving higher and

long-end rates increasing."

However, if Democrats prevail, it could bring higher taxes

on corporations and higher-income households that could weigh on

economic growth. Disinflation is likely and as such, more

aggressive easing by the Federal Reserve would be possible.

Interest rates are likely to decline in this environment, led by

the front end of the curve.

Swaptions, which are options on interest rate swaps, are one

segment of the more than $600 trillion over-the-counter rate

derivatives market. Rate swaps measure the cost of exchanging

fixed-rate cash flows for floating-rate ones, or vice versa, and

are used by investors to hedge interest rate risk.

With the Secured Overnight Financing rate (SOFR) as

reference rate, swaps generally reflect rate expectations.

Payer swaptions were evident on longer maturities from

five-year to 30-year swaps where the cost of implied volatility,

a measure used to price these options, saw a surge a few weeks

ago as online betting odds of Republican former president Donald

Trump winning the election grew on platforms like Polymarket.

It's a toss-up, however, in national polls.

The implied volatility on one-month at-the-money options on

30-year swap rates hit its highest for the year of 31.06 basis

points (bps) on Oct. 21. It slipped on Friday

to 30.5 bps.

"The long end is historically sensitive to fiscal policy

because of the expected increase in Treasury issuance, which is

typically higher on the long end of the curve," said Barclays'

Nashikkar.

HIGHER VOLS FOR LONGER-DATED MATURITIES

Implied vols on one-month options on other longer-dated

maturities from five to 10 years

have also gone up.

"They have increased by an amount that is much higher than

what we have seen in election cycles prior to the 2020

elections," said Bruno Braizinha, senior rates strategist, at

BofA Securities.

As volatility climbed, investors are also betting on a move

higher in longer-dated rates, such as those on 30-year swaps,

about 50 bps higher, in one month.

The cost of longer-dated trades surged to an 18-month high

on Oct. 22 of 33 bps, suggesting increasing

expectation 30-year swap rates will end up 50 bps higher in a

month. That is likely because 30-year Treasury yields will

probably increase as well.

"The worst-case scenarios for bonds are the sweeps and

investors are actively hedging right now, trying to hedge their

portfolios for that," said BofA's Braizinha.

Aside from a Republican sweep, investors are also bracing

for a jumbo move of 18 basis points in Treasury yields in either

direction on Nov. 6 or 7, based on the MOVE index.

That's about 2-1/2 times higher than what the current index is

projecting on average daily moves over a period of one month.

The MOVE index, the benchmark for rate volatility, was 128.4

last Friday, reflecting expectations Treasury yields across most

maturities will move an average of 8 bps per day in either

direction over the next 30 days.

Harley Bassman, MOVE index creator and managing partner at

Simplify Asset Management said option prices anticipate a sharp

move in Treasury yields post-election, perhaps the largest since

the 1991 Gulf War for a known event.

He noted that rate volatility has been a lot higher than in

the stock market, which Bassman felt has become more complacent

about the election.

U.S. stock volatility is more subdued because Bassman thinks

equity markets do not care who gets elected. Both Trump and Vice

President Kamala Harris have suggested significant increases in

the budget deficit through increased fiscal spending, he noted,

and that's good for the stock market and the economy.

"There will be huge deficit spending either way, creating a

large fiscal impetus; ultimately a tailwind pushing the

economy."