Rate/rate derivs trading ideas and strategies

Hello and happy new year!

can anyone please tell what are your favourite sources to get trading ideas and strategies on rate and its derivatives? I would really appreciate your help... will need to pitch some ideas for an interview in S&T and a HF, thanks a lot!!

 

thank you all ! in fact i do have my own ideas, but since i'm quite junior and have no mkt experience, i would like to see what mkt players are thinking, and to see if my ideas are not ridiculous sometimes...

 

Just think about the possible questions and arguments against your idea and try to prepare answers that make sense. Read everything related to your idea that you can find so you have as many things in your mind as possible when answering unexpected questions. If you want to use the forum I think it would be better to post your idea with the pitch and let experienced people ask you questions and you try to answer them and then get feedback on your answers. People here are willing to help, but you have to put in the work, we're not going to do it for you.

 

sure! that's a good advice :)

just an idea coming into my mind right now -- buy a steepener of the $ swap curve: long 10Y swap and short 1Y swap rate, for 3 reasons : 1. As more and more bond investors are moving to shorter duration bonds due to the tapering, pushing their price higher, the short end of the benchmark curve will go down 2. When looking at the 10y US treasury future contract price chart, since December, especially since the previous FOMC meeting, the price has decreased a lot and shows a downward trend, confirming the long term rate increase expectations 3. the 10Y-1Y historical spread shows an uptrend with a current level of 2.7, I would expect the spread continues to go higher up to the similar level as the period of 2001-2005, at about 3.5 Investment horizon is 9 months as the FED would spend most of 2014 to taper gradually; My risk is related to FED policy changes – an even more accommodative monetary policy under Yellen, such as if she sets another condition of tapering based on the quality of the employment.

can you please let me know if this is ridiculous? thanks a lot!

 

Your terminology is a little screwed up. You don't "buy a steepener" and your longs and shorts are the wrong way arnd (remember, if you want rates to go up, that's a short). Other than that, a steepener is certainly a reasonably sensible idea. Some of the starting questions I would ask to get an idea of how you're thinking about it would be: 1) you mention that you're looking at the trsy futures charts. Why choose to do your trade in swaps? 2) why choose 1y as the front leg of the steepener? Why not 2y or 5y or whatever? 3) what are the main risks for such a trade? How can a steepener like this go bad?

 

Thank you Martinghoul! can we say 'long a steepener' instead?
so if i understand you well: short in the rate mkt = pay fix / rec flt in a swap = short bonds = short bond futures = P&L increases with rates 1) i thought the govt bond futures are considered as the benchmarks for the rate mkt in terms of future expectations? 2) i wanted to select 2y as the front leg, it seems that the 2y10y steenpener is more liquid; however since 3 weeks its spread has already gone up a lot and would have less upside potential than 1y10y 3) it will go bad if the monetary policy becomes even more accommodative and if the US economic recovery slows down

what do you think Martinghoul?

 
Best Response

You can just say do/have a steepener. Long and short aren't really applied to curve positions, as they aren't needed.

1) Sorta, but the important thing here is that, wherever possible, you want to analyze the same instruments that you will be using to implement the trade. In your case, for example, given that the 10y bond futures aren't actually 10y, you have a number of factors that potentially separate you analysis from your trade.

2) Right, sure thing, but, since there's no free lunch, what are you giving up when replacing 2y with 1y? You need have a good explanation for the pros and cons of your specific choice.

3) Sure, that's one scenario. You should also be aware of a few other risks, such a LIBOR blowout, for instance, or the unlikely case of unexpected early hikes from Madame Y.

As to carry and rolldown, there are a lot of different views on this out there. I generally like to seep rata the two notions, for clarity. And the point is that one of the key factors to consider when doing these trades and selecting the particular points on the curve is the carry and rolldown characteristics of the trade.

 

thank you msmandoo, not sure how you guys calculate the carry practically? If I think of a vanilla swap as a long fixed cpn bond financed with a floating rate, the carry = fixed rate - current floating rate, on an annual basis. But this is a rough measure as we assume the funding rate constant. Would it be a more sensible to calculate the carry with = forward swap rate - currency par coupon rate e.g. for a 2Y tenor swap, 9m carry = spot of (15m swap rate, 9m forward) - spot of 2Y swap rate But it seems some use = PV (net Interim cashflows + net principal value)/ dv01

what's your idea?

for the steepener i think the long end carry and rolldown are more pronounced than the front end, but not sure how to integrate this into the strategy...do you mean i need to isolate the P&L generated by the carry and rolldown ?

 

http://www.hughchristensen.co.uk/PaperDepository/PaperDepository.html "understanding the yield curve" from salomon brothers is probably a good starting point for rates

londorfr- not sure if you considered this already, but you also have to think about how you weight the trade. if you want pure exposure to the (10y-2y) spread you're going to have to buy far more 2y's than 10y's, because the 10y is much more volatile than the 2y, because it has much longer duration.

 

One way to estimate carry is to calculate the npv of the swap on a forward date (essentially forward swap with fixed rate being the spot rate), then calculate annuity value over life of the swap. The point is that if you want to put a steepener on you want to select points on the curve where carry and rolldown is most attractive. You can consider constructing a matrix where rows represent forward date and columns represent maturity and go from there. I recommend Howard Corbs book for more details.

 

thanks a lot msmandoo; I do have a matrix calculating the carry n roll using fwd swaps but never thought to use it this way.... need to fill the gap b/t theory and practice;

BTW, maybe easier to do a CMS spread instead if want to play with the spread purely

 

thank you all for your help on this curve trade;

Can I also have your view on basis trading please? e.g. the eur usd ccs basis (EUBS3);

Since 6 months, the EUR basis has became much less negative, especially the middle end of the basis curve, indicating an improved situation in the eurozone; I understand the basis can be affected by $ funding liquidity and especially credit in the foreign currency; during the crisis the short tern basis will be very negative and the basis curve slops up rather deeply, while when times are good, the curve is quite flat;

Since the eurozone debt chaos in 2011, the 3M basis has increased by over 100bps; and since Sep13, the 3Y eur basis has increased by 15bps;

I predicted the trend pretty well, but don't know how to trade basis in practice? trade the curve directly or via a CCS swap, or anything else? may i have your insights please? thank you!

In fact I have an idea on trading the TRY basis due to the situation there right now..

 

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