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(Bloomberg) -- Collapsed optionality in TLT (20Y+) and IEF (7-10Y) Treasury ETFs may appeal to investors seeking low-carry hedges to take a more measured portfolio stance, Bloomberg strategist Tanvir Sandhu writes.

• 6-month TLT 35-delta strangles are currently priced at ~3.6%, near all-time cheapness, providing low cost way to hedge a break-out of the range in long-term rates  
• TLT and IEF implied vols have collapsed across the term structure with 3-month implieds near record lows, see chart here
• TLT 6-month implied vol is trading 120bps below realized, lowest since 2015; see chart here
• Realized vol of long-term rates have moved lower this year as hopes of Trump policies sparking reflation crumbled, with inflation breakevens falling to pre-Trump levels following three downward surprises to core inflation and decline in oil prices, while financial conditions are still seen supportive of growth
• Probability of a spike in risk aversion is increasing as equity markets and economic expectations have rarely been so far apart, with Fed now seemingly concerned about asset-price bubbles given hawkish tone against U.S. economy losing momentum; see chart here
  • A regime shift in vol will be best captured with long-convexity exposure combined with tactical shorts rather than tail-risk strategies betting on mean-reverting vol spikes; see analysis here
• NOTE: See series of analyses since December warning of the scope for yields to decline given the lofty fiscal expectations, peak inflation dynamics and Fed terminal rate lacking escape velocity; examples here, here and here
• NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Tanvir Sandhu in London at tsandhu17@bloomberg.net To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net Anil Varma