Long term carry trade mechanics

[Cygnus Atratus]

Quote from monty21:

To be completely honest, I don't think too many ET members do the carry trades. Whatever you hear, take with a grain of salt.

I'd also recommend trying investopdia... here are some articles:

http://www.investopedia.com/articles/forex/09/credit-crisis-carry-trade.asp

http://www.investopedia.com/articles/forex/07/carry_trade.asp

http://www.investopedia.com/articles/forex/07/carry_currency.asp

Nope, I did short the Carry trade last year, but be careful how you position yourself, approximately NZD$ 5 billion worth of Uridashi bonds are maturing this month and looks like only 15% is going to be rolled over, combined with record falls in wholesale milk prices be careful if you do intergrate NZD/JPY in your carry trade.

 

[Martinghoul]

Quote from markettimer:

I actually think the JGB futures combine both. Let's consider how the trade would respond to two shocks: (1) yen depreciation vs. dollar; (2) higher Japanese interest rates. In both cases, the JGB futures would fall. Currently the carry on a JGB futures should be negative, since short term rates in the US are below long term rates in Japan. However, if short term rates in the US rise, the trade will have a positive carry. Wouldn't rolling JGB futures have a payoff similar to shorting a constant maturity JGB bond in the repo market as you describe?

Is it feasible for retail traders to short sell bonds directly? I thought practice that was just for institutions.

I agree with you that some of the FX aspect will be captured when you use JGB futures.

However, the whole point of the carry trade is to borrow cash in yen to lend in a higher-yielding ccy. You need to actually do that and take on the risk (through actual cash) in order to be rewarded with the carry. When you do it through futures, you're, effectively, lending/borrowing in forward space, where all the carry is already priced in.

Using JGB futures does give you a similar payoff, but it's not the same. I don't honestly know whether you can do it as a retail trader.

 

[markettimer]

Quote from Martinghoul:

I agree with you that some of the FX aspect will be captured when you use JGB futures.

However, the whole point of the carry trade is to borrow cash in yen to lend in a higher-yielding ccy. You need to actually do that and take on the risk (through actual cash) in order to be rewarded with the carry. When you do it through futures, you're, effectively, lending/borrowing in forward space, where all the carry is already priced in.

Using JGB futures does give you a similar payoff, but it's not the same. I don't honestly know whether you can do it as a retail trader.

Yes, one leg of the trade is to short the JGB futures, which is effectively a fixed-to-floating swap with the borrowing done in yen. The second leg of the trade is to buy a higher yielding asset.

 

[Martinghoul]

Quote from markettimer:

Yes, one leg of the trade is to short the JGB futures, which is effectively a fixed-to-floating swap with the borrowing done in yen. The second leg of the trade is to buy a higher yielding asset.

Yes, that's right, but it's a fwd-starting fixed-to-floating swap (starts out of the date of futures maturity). That's precisely why the carry dynamics are different...

 

[Stewenson133]

wow... very interesting thanks all

 

[Aaron]

Quote from markettimer:

Yes, one leg of the trade is to short the JGB futures, which is effectively a fixed-to-floating swap with the borrowing done in yen. The second leg of the trade is to buy a higher yielding asset.

Yes, it is a fixed-to-floating swap, but there is no borrowing done. If you have a JGB position, your profit or loss will be unaffected by changes in the exchange rate. (Except for a second order effect when you have to repatriate your profit.)

The second leg of the trade is to short the yen futures (or do an equivalent FX trade). Now you can go ahead and buy a higher yielding asset, converting into the higher yielding currency if needed.

Say you short the JGB, short a yen future, and buy high yielding Altria single stock futures.... You will have, in effect, borrowed long term in yen to invest in Altria. You are paying a long term yen rate on the short JGB, earning a short term yen rate on the short JGB, paying a short term yen rate on the short yen future and earning a short term dollar rate with the short yen future, paying a short term dollar rate with the Altria future, and earning the Altria yield. Net effect: short the yen, borrowing long in yen, & long Altria.

Yes? No? Maybe?

Good trading,
Aaron Schindler
Schindler Trading