Hedge fund managers expecting a rise in U.S. interest rates are making ever-larger wagers through complex derivatives, according to investment dealers. Particularly popular now are options on the S&P 500 that pay out only if ten-year rates rise past a certain level before expiration. Rate-contingent S&P 500 put options enable hedge funds to get inexpensive downside equity and upside rate exposure at the same time.
The contracts pay off if the S&P dips below 95 percent of its current level, contingent upon a hike in ten-year yields to levels between 2.7 and 3 percent. The cost of the complex contracts is significantly lower -- as much as 80 percent cheaper -- than vanilla puts on the equity benchmark.
Hedge managers trading the contracts are banking on a continued economic recovery forcing a rate rise which, in turn, could cool investor ardor for equities.