What downside would there be in buying way out-of-the-money interest rate options, say options that are ATM if interest rates hit 7% within 10 years and holding that option position year after year?
I’m looking to bet on a very unlikely scenario in which we’ll see sudden and dangerous spikes in inflation and the central banks will need to start hiking up interest rates very aggressively to reign in it.
Are there some alternative products that can be used to achieve the same goal more efficiently?
I’m looking for a pretty likely loss of my investment but a uuuuuuge payoff if I’m right.
The item to consider is that unless rates instantaneously jump from current levels to the 7% or similar levels overnight, any gradual changes to the rate will be baked into gradual changes to the option price. So reestablishing those positions after expiry will not be a static endeavor.
Not about inflation specifically, but they have the ETF tail that is supposed to go up in troubled markets. Perhaps that’s correlated with the outcome you are trying to get exposure to?
Significantly out of the money LEAPs on insurance companies could be an option here. Pennies for the premiums and retirement money if it hits, unlikely as it is.
Not sure anyone will sell you 10y options. Plus you could be long quite a bit of gamma I would have thought.
I’d say your best bet is through TIPS, shorting the corresponding maturity non inflation adjusted treasuries to manage rates exposure. I’ve never traded TIPS though, just vanilla bonds, so this is just a suggestion.
Of course that’s more of a linear trade rather than a tail-event type pay off. Maybe a better way is to look for the event that would cause markets to rethink inflation assumptions. Or maybe just get long dated options on gold ETFs.
“In summary, a combination of Tips held to maturity, commodity-related assets and short-term Treasury bills is likely to offer reasonable protection against inflation shocks.”
Looks like there really isn’t a way to really construct such a jackpot tail risk structure that I’m looking for.
Do you guys think buying Bitcoin could work as a proxy for what I’m looking to do. This is how I see it: if we see 5-10% interest rates within the next 10 years, the world is on the verge of blowing up. ( I believe markets are pricing interest rates to remain at 0% for the next 8 years at least). So, in time of such calamity, Bitcoin and other cryptos would probably increase in value? Please shoot down my idea with your best shot.
No, but I think the kind of instrument you are imagining could be achieved as a cryptocurrency based derivative. Imagine an interest rate swap of LIBOR+50bps for the spot yield on something - a Treasury or a muni bond (my personal choice) let’s say. The spread is initially small or 0, but if your scenario pans out, you win big. I don’t know if this could be accomplished with traditional derivatives (at least not for consultants like me who aren’t institutional investors) but on a crypto exchange that’s more flexible and you can even design your own smart contracts, there’s no reason why it can’t be done.