On April 21, Bill Gross subtly suggested [6] that German Bunds may be overbought:
Gross: German 10yr Bunds = The short of a lifetime. Better than the pound in 1993. Only question is Timing / ECB QE
— Janus Capital (@JanusCapital) April 21, 2015 [7]
Around a week later, Bunds begin to sell-off hard and as April turned to May, a “cascade of small events created a large splash in a structurally ever-thinner mkt” (to quote HSBC), triggering a veritable rout [8] that sent yields on the 10-year from around 10bps when Gross made his short call to a high of more than 70bps during Thursday’s session. The sell-off has been variously attributed to factors ranging from profit-taking, to scarce liquidity, to the frontrunning [9] of what is expected to be a positive month for EGB supply.
Given the above, one might have expected that Gross, assuming he followed his own advice, has fared well over the last several weeks. Unfortunately, it appears he may have bet that Bunds would remain range-bound over the short-term (perhaps believing that Mario Draghi’s bazooka would be enough to prevent a dramatic sell-off) because as Bloomberg reports, by the end of March, Gross had sold puts on Bund futures in an amount equal to nearly 5% of his fund’s net asset value. Those puts have risen by as much as 11,000% in the case of one contract, and 6,000% in the case of another.
Via Bloomberg [10]:
Gross compared his strategy to selling insurance, saying investors were now willing to pay fatter premiums to protect their holdings against future bond market turbulence. This strategy positioned Janus Global Unconstrained to boost returns with these premiums as long as volatility remained low, but also exposed the fund to losses should markets become more turbulent.
Gross at the end of March had sold both put and call options on futures contracts tied to 10-year U.S. Treasuries as well as German bonds. Among them were puts on German bund futures whose adjusted face value equaled about 4.6 percent of Janus Global Unconstrained’s net assets as of March 31.
With the German bunds falling, the prices of the put options soared. One contract that would obligate Janus Global Unconstrained to buy futures on German bunds later this month has jumped more than 6,000 percent since late April, and another has surged almost 11,000 percent, according to data compiled by Bloomberg.
Put options that Gross sold short on U.S. Treasury futures have also jumped in price, but to a much lesser degree than those on German bunds. One such put option on futures for 10-year Treasuries is up more than 500 percent since April 21, according to data compiled by Bloomberg.
Gross said in the April 29 interview with Bloomberg Television that he hadn’t changed his positions. German 10-year bond yields surged the most in two years that day, a jump that surprised even Gross, who said he had expected the yields to rise, and prices to fall, over an extended period of time.
‘‘Today wasn’t a good example for my case because prices moved a lot,” Gross said in the interview.
In other words, Gross — like the ECB — assumed the bursting of the Bund bubble would unfold over a longer period of time and in a measured fashion and so, he figured that in the interim he would take advantage of elevated premiums by selling puts. Unfortunately, his “short of a lifetime” call sparked panic selling into a structurally thin market. That is, he made the right call but made the mistake of assuming the market is still to some degree efficient.
Or, to use Gross’ own words: “When you sell volatility and you get volatility, then it’s not a good thing.” And boy has it been volatile.
[11]
[12]
