I'm looking to hedge against rising thirty-year mortgage rates for the short term while we are house shopping. Would buying an appropriate number of put options on something like IEF (iShares Barclays 7-10 Year Treasury Bond Fund ) be a close enough hedge to accomplish this?

I was originally going to buy options on the 10-year treasury futures until I discovered the ridiculous cash on hand requirements from Interactive Brokers to buy them.

  • Why do you need to hold actual bonds if you bought puts? – CQM Apr 9 '15 at 17:26
  • @CQM appears that my current brokerage (InteractiveBrokers) has probably mixed up the requirements for selling contracts with those for buying. For some reason, they are placing a huge cash requirement (~10X the price of the contracts) on to the account. I can only assume this is accidental, unless they are trying to drive away futures option traders from their service. I confirmed with the risk department at the exchange that this is not an exchange requirement, even though IB told me that it was. – glenviewjeff Apr 9 '15 at 18:06
  • Make a synthetic long put then ;) double the commissions though – CQM Apr 9 '15 at 18:18
  • @CQM I assume from the wink that you're joking, and if I understand the concept correctly, this would require selling the underlying 10-year-treasury futures as a part of the transaction. That transaction would require a bond holding at any brokerage, not just ones who seem to be behaving ignorantly. – glenviewjeff Apr 9 '15 at 18:38
  • 1
    well I wasn't joking, but why do you need to hold bonds to hold the bond futures? Yes a synthetic put does involve the underlying. Perhaps an ETF would more appropriately help you here, depending on how it calculates asset values in the long term, long dated in the money calls or long dated in the money puts – CQM Apr 9 '15 at 18:48

When interest rates go up Bonds go down in price so I like the idea. Its just that options inherently become less valuable over time as they get closer to their exp date. Would you be able to compare that against buying your house earlier and paying PMI for 5 years?

You could be in your house earlier pay about $3500 in pmi. Then Every month you stay in the house after the PMI would be money you saved because you bought now before interest rates went up.

So this is not a true answer but it might spark some interesting discussions.

| improve this answer | |
  • Yes, the declining time value is inherent in options and akin to the cost of the hedge. There's no free lunch. – glenviewjeff Apr 10 '15 at 14:24
  • I don't think this would ever be profitable for someone with an adjustable rate mortgage--the purpose for me is for the short term while house shopping in case interest rates spike. We'd be getting a 30-year fixed mortgage. – glenviewjeff Apr 10 '15 at 14:26
  • To clarify, the situation I'm describing isn't waiting to buy a house until saving for down payment, it's if you need to wait to move for any other reason than that. It could be because of a job/school commitment or that you can't yet find the right house in the current market. – glenviewjeff Apr 11 '15 at 14:31

This should be a good short-term hedge against rising 30-year mortgage rates while shopping for a house. If you can afford a small swing, but if there's >1/2% rise in mortgage rates, you can recoup some of the added expense.

To keep the cost of the hedge down, you should be able to buy far out-of-the-money puts on IEF. Doing so in an IRA account will avoid taxes on the gains. If interest rates rise significantly and you sell the contract before expiration at the time you lock the mortgage, you should end up with a lump sum gain in your IRA. Then just consider your additional mortgage payments as taking the place of what would have been IRA/401k contributions.

The way I look at it is that the amount "out of the money" will act as a deductible on a mortgage rate insurance policy, and the cost per contract is essentially the insurance premium. Just buy the number of contracts appropriate to cover what you believe is a good representation the mortgage rate risk, factoring in how long you expect to stay in the house.

The relationship between the 10-year treasury and 30-year fixed mortgage rates is well described in this New York Times article.

Regarding the correlation between IEF and 10-year treasury index:

The correlation coefficient between the 10-year treasury and IEF has almost always been -0.99, which looks like a darn good security to buy options to hedge against the 10-year treasury rates changing. See the correlation plot below:


| improve this answer | |
  • A note explaining the down vote would be helpful. – glenviewjeff Apr 10 '15 at 14:23

There are "bear" etfs like Direxion Daily 20+ Year Treasury Bear 3x ETF (TMV) that are triple leveraged. Buying 1/3rd of TMV of the position you need to cover on margin will give the same result.

| improve this answer | |
  • The problem with buying even triple leveraged ETF is that we're only about 80% sure we'll find a house in the next few months. Putting so much money at stake for loss directly into shares is too much risk for my taste, even if triple leveraged. In my particular case, I need to cover about $95k per 1% increase in interest rates. My calculations show I would need to hold about $75k in one of these funds. I'm looking for more of the equivalent to an insurance policy that has a time premium and deductible, which cheap out-of-the-money options would provide. – glenviewjeff Apr 12 '15 at 13:37
  • Could you re-edit the answer and explain what "TANS" was? – glenviewjeff Apr 12 '15 at 13:42

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.