Carry trades
- Thread starter just21
- Start date
Going long long-bond futures is the equivalent of the carry trade. The discount from spot is due to the difference between long rates and short rates and will gradually disappear as the futures contract approaches expiration. Unless you lose an offsetting amount due to long rates increasing, you will profit as the discount to spot disappears.
A hedge fund may spot an off the run Treasury that's trading cheap to the contract. Or as you allude, they may be involved in higher yield, non-exchange traded markets.
The discount to spot is a function of long rates minus short rates. The long rate or yield on a long bond is a combination of the coupon and the amortization of the discount or premium versus par. So, in short, I think the answer to your question is "yes".
Buying long bond futures is just one version of the carry trade. Like you say, you might want the version where you buy mortgage bonds (agencies) instead. Or maybe you want to buy foreign bonds, or corporates, or munis, or an off the run Treasury (like Egotrader said), or whatever.
Some hedge funds might also stick with the cash market because futures contracts are under CFTC jurisdication and the fund might not want to deal with the additional compliance issues.
Here's another version of the carry trade a retail investor could do: In your brokerage account buy high yielding preferred stock, stock, or REIT's on margin. As always, the defining characteristic of a carry trade is that you are borrowing at short term rates and investing in a longer duration instrument to get a higher yield.
I believe that technically, any trade that takes advantage of interest rate differentials is a carry trade.
The bonds are one, but probably the biggest (most liquid) carry trade in the world is any time you go long one currency against the other, since 90% of the (value) differential between two currencies is essententially interest rate.
A few years back, the dollar was super strong against the Yen. So what people did is "borrow yen and lend dollars" by going long Yen and shorting the Dollar. This strategy was an ATM machine for a while...
As far as being able to execute this kind of trade, just take a look at Currency Futures at the Chicago MERC. In order to do it in the spot market you essentially have to be a big player or an institution.
I too am learning more and more about these trades...
nitro
The bonds are one, but probably the biggest (most liquid) carry trade in the world is any time you go long one currency against the other, since 90% of the (value) differential between two currencies is essententially interest rate.
A few years back, the dollar was super strong against the Yen. So what people did is "borrow yen and lend dollars" by going long Yen and shorting the Dollar. This strategy was an ATM machine for a while...
As far as being able to execute this kind of trade, just take a look at Currency Futures at the Chicago MERC. In order to do it in the spot market you essentially have to be a big player or an institution.
I too am learning more and more about these trades...
nitro
Didn't LTCM blow up using carry trades?
Runningbear
Runningbear