Eurodollar spreading

Quote from nazzdack:

1) You have almost 3 months "invested" in this thread and you're back where you started? :confused: :eek:
2) Instead of doing "exotic" combinations in Eurodollars, wouldn't it just be easier just to take "flyers" in the ultra-bond? :confused: :D
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I don't understand how these are exotic combinations.. flys, condors, and spreads are like super common in intra contract spreading.... I don't consider that exotic.. I am just trying to get my mind about what risks i'm taking and were the PNL is being derived from in these trades..
 
Quote from Maverick74:

No, you are not lending. You are betting on a future 3 month strip of libor interest. The actual banks who are lending are getting that interest. You are purchasing a present discount value of that forward rate. THAT is why you are seeing convergence.
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I kind of thought of it when you are trading a long calender and it rolls off the curve you are making the changing preference of the market from long term interest rates to shorter term interest rates. As we know the market typically demands higher interest rates in exchange for tying their liquidity up for longer. This is why interest rates tend to have a positive sloping curve to them.. Please correct me as this stuff is still loose in my head.. So if I put a steepener spread or fly on it will slowly roll from a flatter farther out part of the curve to a steeper front part of the curve (If the curve doesn't change) meaning most things being equal..
 
I talked in chat for a while. And resolved some of my questions about why the curve is positive sloping and where the pnl is derived from in trading spread/flys etc... Took me a minute to figure it out.. If the rate stays low they will converge to the future "low zero" rate.. But the market prices a rate hike out in the future, or the risk of it.. Much like the vix futures where the futures trade at a premium because all the risk is up!
 
Quote from Maverick74:

Regarding a steepener, I told you there is an ETF for both the flattener and the steepener that you could put on simply or use them just for reference. Most people would probably tell you that the yield curve is expecting to steepen. And there in lies the rub. The forward curve is pricing that in. Therefore, if you want to make money off of this, you either need to find a mispricing somewhere on the curve or go the other way. Markets are prickly like that, they try to make it hard to make the obvious trade.
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What ETF flattener/steepener ETF's I've got 18 years sober but never full recovered my short term memory.. Thanks for always bearing with me Mav!
 
Quote from Martinghoul:

Well, why don't you think of it this way? You're agreeing to lend notionally at some future point in time at a rate implied by the price you pay. This way, you're lending notionally, but it also happens to be a bet on what will happen in the future. Makes sense?
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agreeing to lend notionally? isn't lending anything though.. When you buy a Eurodollar your betting that the future spot price will be higher or lower then what the implied rate is that you buy that Eurodollar future at. So if you believe rates were going to stay zero you could buy the future and it will converge towards zero.. You are then deciding to bear the rate hike risk....

I would think if rates have been zero for a long period of time.. buying Eurodollars that converge in the future to that low projected future spot would be a rather dangerous endeavor.. As periods of low volatility build imbalances in the system.. Just like in volatility trading.. So you end up with more and more people on one side of the market. Its like the only way to make money is to buy Eurodollars and hope the train doesn't hit ya.. Might as well smuggle drugs and hope you made enough money to buy your way out of jail kind of strategy.. Maybe not that bad..
 
Quote from cdcaveman:

What ETF flattener/steepener ETF's I've got 18 years sober but never full recovered my short term memory.. Thanks for always bearing with me Mav!
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The ETFs are FLAT and STPP, and do what the names imply.
 
Quote from cdcaveman:

agreeing to lend notionally? isn't lending anything though.. When you buy a Eurodollar your betting that the future spot price will be higher or lower then what the implied rate is that you buy that Eurodollar future at. So if you believe rates were going to stay zero you could buy the future and it will converge towards zero.. You are then deciding to bear the rate hike risk....

I would think if rates have been zero for a long period of time.. buying Eurodollars that converge in the future to that low projected future spot would be a rather dangerous endeavor.. As periods of low volatility build imbalances in the system.. Just like in volatility trading.. So you end up with more and more people on one side of the market. Its like the only way to make money is to buy Eurodollars and hope the train doesn't hit ya.. Might as well smuggle drugs and hope you made enough money to buy your way out of jail kind of strategy.. Maybe not that bad..
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Well, yes and no. The front month strip really has no interest rate risk. So if you continue to roll you are fine. Think of the front month as a liquidity parking lot. I mean obviously if you are a bank and you are using the repo rates for financing and repo rates spike up, they are at risk of not being able to afford to roll or getting squeezed on a swap. But for you, the lone buyer of a 3 month strip in the front, you are not really risking anything other then opportunity cost. You could have always bought ICPT with that money. :)
 
I don't really like how you are using the word convergence. I like to use that term in relation to two different products moving back towards value. What you are doing is buying the present discount value of a future cash flow, like a savings bond. Instead of getting a coupon for interest you are getting a discount on the principal based on the implied rate. So the convergence is not an "edge". Neither is the 10 bps I get paid on my checking account. :)
 
Quote from Maverick74:

I don't really like how you are using the word convergence. I like to use that term in relation to two different products moving back towards value. What you are doing is buying the present discount value of a future cash flow, like a savings bond.
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buying the present discount value of a future cash flow..

hmmm haha.... Can you explain what the means?
 
Quote from cdcaveman:
agreeing to lend notionally? isn't lending anything though.. When you buy a Eurodollar your betting that the future spot price will be higher or lower then what the implied rate is that you buy that Eurodollar future at. So if you believe rates were going to stay zero you could buy the future and it will converge towards zero.. You are then deciding to bear the rate hike risk....
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Yes, but if you think about it, you will conclude that the above is, in fact, equivalent to agreeing to make a notional 3m loan at a future date at a particular price.
I would think if rates have been zero for a long period of time.. buying Eurodollars that converge in the future to that low projected future spot would be a rather dangerous endeavor.. As periods of low volatility build imbalances in the system.. Just like in volatility trading.. So you end up with more and more people on one side of the market. Its like the only way to make money is to buy Eurodollars and hope the train doesn't hit ya.. Might as well smuggle drugs and hope you made enough money to buy your way out of jail kind of strategy.. Maybe not that bad..
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Well, that's exactly the discussion that's occurring now and which makes these things so interesting. As to the "dangerous endeavor", yes, you're probably right, unless you can seriously imagine the US turning into Japan. If you kept buying Euroyen or JGBs in the 90s, you'd be sipping pina coladas on a beach somewhere by now.

I might add that I disagree with Maverick. There's nothing wrong with using the term "convergence". It's not the term commonly used (the industry uses "rolldown"), but the meaning is the same. Moreover, even now, during the tamest of times for rates, the front contract contains some risk premium, however tiny. Specifically, with the actual 3M LIBOR fixing stable at arnd 24bps, the H4 contract currently implies 25.5bps. If you felt that it was worth it, you could "earn" this 1.5bp by buying the contract and sitting on it till maturity. I wouldn't call this "edge" and I would not recommend doing it. However, make no mistake about it, fading excessive risk premium by earning the rolldown (aka doing the "covergence" trade) can be genuine "edge". Bill Gross is doing exactly this at the moment with however many bazillions of dollars, which is why he keeps talking his book at every opportunity.
 
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