Originally posted at Portfolioist.com.
There was a recent story in the WSJ titled Treasury Market Gets Volatile. The article notes that a widely-followed measure of government bond volatility, the MOVE index from Merrill Lynch, has risen from 75 in August to 109 today.
The MOVE index is simply derived from options prices on bonds. The more expensive the options are, the higher the market expects volatility to be. As such, the rise in the index really does mean that the volatility of Treasury bonds has increased by 45% from August through November.
You can chart the MOVE index over different time frames here.
This is how it's behaved over the past year:
(Source: Bloomberg LP)
The risk level implicit in historically low yields on government bonds is very clear in the rising levels of the MOVE index. This is not a new phenomenon--the options market has been signaling for some time that treasury bonds look very risky. In an article at the start of October, I noted that the implied volatility in long-term treasuries was higher than that of junk bonds. Over on the Bogleheads, the use of implied volatility to infer risk in bonds was treated with some skepticism, which surprised me. Implied volatility is a standard measure of risk, albeit one that the vast majority of individual investors will not have encountered. The fact that the WSJ saw fit to publish an article on the use of this type of risk measure for bonds suggests, however, that perhaps we will be seeing a deeper discussion of bond risk in the financial media.
For those who wish to see the numbers for themselves, I am partial to the use of options on bond ETFs. High yield bonds have lower implied volatility than either long-term government bonds or the S&P500.
Note: I am comparing the implied volatility on PUT options because these options are a better reflection of downside risk.
These results are for short-term options, but they reflect an odd sentiment that long-term bonds are highly risky at this time. The risk comes not because anyone thinks the US government will default on its debts but rather that the current yields are so so low that the future purchasing power of coupon payments is in serious jeopardy.
I am not suggesting long-term bonds are not worthy of consideration for some allocation in long-term portfolios. I am concerned that too many people see government bonds as a safe asset class, however.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.