(Bloomberg) -- Traders in US Treasury options are positioning for a bond rally in the aftermath of crucial inflation data on Wednesday.

The benchmark 10-year note advanced ahead of the report, sending the yield down two basis points to 4.42%, the lowest since the previous inflation release five weeks ago. European bonds posted even stronger gains, with benchmark German and UK rates both falling as much as seven basis points. 

Heavy buying over the past week has centered on options that would stand to benefit from US 10-year yields dropping to roughly 4.3%, the lowest in more than a month. One high-risk trade stood out: It would reap a potential $15 million windfall on a wager of just $150,000 should the 10-year benchmark fall even further to 4.25% by May 24. 

The bet on a rally comes as bonds regained some ground following a brutal April, when prices slumped and yields soared to their highs for the year on waning expectations for interest-rate cuts. Since then, Federal Reserve Chair Jerome Powell eased market concerns by talking down the need for rate hikes. 

Investors now await April data on US consumer prices, which will be key in determining whether the rally pushes ahead. The core inflation measure which excludes more volatile components is forecast to slow to 0.3% on a monthly basis, according to a Bloomberg survey of economists.

“There’s been a lot of positioning both ways, but most recently there’s been a lot more leaning toward the possibility of easing, and conceivably the chance of aggressive easing,” said Alex Manzara, a derivatives broker at R.J. O’Brien & Associates. “The market is clearly concerned about something going bad that could lead to rapid easing.”

Open interest, or the amount of new positioning, surged recently in options tied to the so-called 110.00 call strike, which pairs with a roughly 4.3% 10-year yield level, according to CME data. Buying was concentrated in the June tenor expiring May 24, capturing this week’s big economic news including the reports on producer and consumer prices.

Meanwhile, asset managers continued to add to long bets in futures, adding to bullish positions for a fourth week in a row, data from the Commodity Futures Trading Commission shows.

Caution is still evident in some parts of the market. Tuesday’s JPMorgan Chase & Co.’s client survey showed a slight uptick of short positions in the cash market for Treasuries, marking a shift out of neutral. Notably, the past three consumer price index reports have surprised to the upside, confounding bulls.

Read more: High-Risk Options Bet on Bond Rally at Risk of Losing Millions

Even so, the futures market has turned less bearish since last week’s jobs report. Traders unwound bearish futures positions linked to the Fed-sensitive Secured Overnight Financing Rate, removing hedges against potential rate hikes and reviving bets on easing. New long positions have also emerged across various tenors of the futures strip. The result is a pullback from the severe bearishness of late April, though short positions do remain.

“Positioning-wise, the bifurcation of the current regime offers less of a directional clue,” wrote Citigroup Inc.’s Ed Acton in a note Tuesday. “Tactical positioning is now getting longer vs a bearish structural short.”

Notable options flows include a large bullish “screen” trade, made electronically at a cost or premium of $4 million and appearing as new risk. The same dovish protection was bought again over Tuesday’s early Asia session. In a similar theme, there has been heavy buying also of risky option strategies known as risk-reversals, where calls are funded by selling puts. 

Here’s a rundown of the latest positioning indicators across the rates market: 

Asset Manager Duration Bump

In the week leading up to May 7 — capturing the aftermath of both the May 1 Fed policy announcement and May 3 payrolls report — asset managers boosted so-called net duration longs for the fourth week in a row. Most of the weekly gains were seen in the long-bond futures, where $2.5 million per basis point in net longs were added. Hedge funds took the other side, extending net short positioning by roughly 200,000 10-year note futures on the week, which included a net short add of around $7.7 million per basis point in the five-year tenor. 

JPMorgan Survey Shorts Rise

In the cash market, investors became slightly more bearish, nudging short positions to a two-week high, according to JPMorgan’s latest survey of Treasury clients. The survey covers the week leading up to May 13. 

Treasury Skew Neutral

The cost of hedging against a Treasury selloff in the long end of the curve continues to erode from a stretched premium for put options about a month ago. The so-called skew in the front end and belly of the curve continues to favor a small premium paid for hedging a rally, while the skew on the 10-year tenor is roughly neutral. Beyond the recent flurry of upside protection on 10-year note futures seen over the past week, there has been elevated “strangle” flows including a ratio 4x1 seller seen Monday.

Swaption Activity Still Biased Toward Selling Vol, Barclays Says

SOFR Options Most Active

The most active SOFR strike over the past week was the 94.6875, helped by recent flows including heavy selling of the Dec24 94.6875/94.4375 put spread and buying of the Jun24 94.6875/94.75/94.8125 call fly. Weekly gains in the 94.875 strike were supported through buying of the Sep24 94.875 straddle and the Jun24 94.75/94.8125/94.875 call fly. 

SOFR Options Heat Map

Open interest in the SOFR Dec24 96.00 and 97.00 calls has risen sharply over the past week, as positioning has built substantially to around 185,000 in the SFRZ4 96.00/97.00 call spread, which was bought again at a level of 5.5 in 15,000 on Monday for new risk. The most crowded SOFR options strike out to the Dec24 tenor is now the 95.50 strike, where a large amount of open interest can be seen in the Jun24 calls. The Jun24 options expiry is June 14, falling two days after the next Fed policy announcement and the May CPI data, which is due the same day. 

--With assistance from Elizabeth Stanton, Aline Oyamada and James Hirai.

(Adds latest market moves in second paragraph, inflation forecast in fifth.)

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