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Extreme Options Positions Are Trade Signal to Morgan Stanley

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                Extreme Options Positions Are Trade Signal to Morgan Stanley

Investors seeking winning strategies across asset classes might want to take a look at how traders are positioned in options markets to get an idea of what’s coming.

A Morgan Stanley study of about 20 assets from currencies to Treasuries found traders could earn “significantly above average” returns by looking for what the paper’s authors called extreme positioning. That’s when the gap between longs and shorts as a percentage of open interest was more than two standard deviations from what’s typical.

Some assets — most notably equities and U.S. government bonds — tended to move in the opposite direction of how large speculators were positioning themselves, while commodities and currencies were more likely to perform in line with the bets compiled in weekly data from the U.S. Commodity Futures Trading Commission. Morgan Stanley said trades based on the strategy led to a return of 5.5 percent in the three months after the extreme positioning threshold was breached.

“Historical performance suggests that trading strategies based on positioning can work with favorable returns,” analysts including Elizabeth Volynsky wrote in a note.

Based on the latest data from the CFTC, investors following this strategy should bet on gains in the Mexican peso and a decline in two-year U.S. swap rates, Morgan Stanley said. Russell 2000, Brazilian real and dollar positioning suggested those assets are close to “buy” territory, but conditions haven’t quite met the threshold.

Bank of America Merrill Lynch is on the same page as Morgan Stanley on the link between buildups of large speculative net positioning in U.S. 10-year futures and the outlook for the notes.

Analyzing open interest in Treasury futures options going back to January 2012, BofAML said in a note yesterday it found a relatively high frequency of contrarian rate moves over the next week and month when net positioning became large enough. It advised investors to consider speculative positioning while forming near-term duration views.

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