Please look at the futures again. They do not deliver a basket, rather they will deliver a bond, which will be the cheapest-to-deliver. In any case, you will not care about that as you only need exposure to the instrument, not the instrument itself.
You are going to need someone that will let you do the repo to short the cash bonds. Hard to do unless you have enough capital to get the relationship.
Thanks. I am confused by the contract descriptions (from Eurex website):
futures contracts based on a notional long-term debt instruments issued by the Federal Republic of Germany, with a remaining term of 8.5 to 10.5 years. It bears a notional coupon rate of six percent. Contract value is EUR 100,000 and the minimum price change is 0.01 percent, equivalent to a value of EUR 10.
and the Italian future underlying are
Notional short-, mid- and long-term debt instruments issued by the Republic of Italy with a remaining term of 2 to 3.25 years (short-term), respectively 4.5 to 6 years (mid-term) and 8.5 to 11 years (long-term) with a notional coupon of 6 percent. Mid- and long-term debt instruments must have an original maturity of no longer than 16 years.
My interpretation was that these futures deliver a basket, but apparently I am wrong on this point. Is there any way of figuring out exactly which bonds are the underlying, or should I, as you said, just not worry about this? In theory I would like to make sure that I am trading basically equivalent (i.e. same maturity) bonds.
At any given point in the life of the contract one bond in the deliverable basket will be the cheapest-to-deliver (if you had to deliver a bond to someone, and you had a choice, you would deliver the one that would cost you least, right?). CTD is influenced by a number of things, such as current financing costs and the composition of the deliverable basket, but unless you want to take or make delivery (which almost no one ever does) the only thing you need to know is that the futures contract will trade like one bond... namely the CTD, and most of the effect will be in the general up/down movement of rates, so it is a second-order detail which bond is the CTD. The one thing that CTD does tell you is the DV01 of the bonds and, hence, the futures contract. If you are concerned about drift in the hedge ratio then you might want to keep track of the shifts in CTD (if there are any).
If you want to short a cash bond you have to find someone who will lend you the bond in order for you to sell it. This is a repo. Works much the same way as shorting a stock. So, you have to have an arrangement with a prime broker who will do this for you. Merlin Securities might be worth a shot since they specialize in smaller accounts, but you still have to have a good chunk in order for it to be worth their while.
I suggest you read up on LTCM and such since they famously blew up on these types of "convergence trades".
At any given point in the life of the contract one bond in the deliverable basket will be the cheapest-to-deliver (if you had to deliver a bond to someone, and you had a choice, you would deliver the one that would cost you least, right?). CTD is influenced by a number of things, such as current financing costs and the composition of the deliverable basket, but unless you want to take or make delivery (which almost no one ever does) the only thing you need to know is that the futures contract will trade like one bond... namely the CTD, and most of the effect will be in the general up/down movement of rates, so it is a second-order detail which bond is the CTD. The one thing that CTD does tell you is the DV01 of the bonds and, hence, the futures contract. If you are concerned about drift in the hedge ratio then you might want to keep track of the shifts in CTD (if there are any).
If you want to short a cash bond you have to find someone who will lend you the bond in order for you to sell it. This is a repo. Works much the same way as shorting a stock. So, you have to have an arrangement with a prime broker who will do this for you. Merlin Securities might be worth a shot since they specialize in smaller accounts, but you still have to have a good chunk in order for it to be worth their while.
I suggest you read up on LTCM and such since they famously blew up on these types of "convergence trades".
Thanks for the comments everyone, very informative and helpful! Well, it looks like I don't have the capital to actually get in as an institutional trader, so it looks like futures are the way to go.
Also, I am familiar with LTCM -- I think the situation here is quite different. So far it has been looking like there is actually a chance of default by Italy or Spain; my assumption is that a coalition of Eurozone countries and possibly others, particularly the US and Japan, will find it politically err ... inviable to let Spain or Italy default, and that this hasn't been priced in yet by the market (although it looks like it already is starting to). Just a little of my reasoning behind the trade.
I am in the club that cannot short the bonds and must play with the "futures".
Btw, to the best of my knowledge IB does not provide physical delivery of EU Bonds, isn't it? It just provides physical delivery of assets that can stay in the account.
As for considering the future as the underlining, I am not really feeling comfortable with that. For example if i am long with a bond and "something goes wrong" I can always keep it till the end. Is there any way to replicate this strategy with the futures?
Quote from hft_boy:
I'm not particularly interested in these futures, because I couldn't find an exact equivalent for German bonds, and I don't particularly want to construct a synthetic basket of German bonds, mostly because of capital constraints.
Can you do this with IB?
P.S: i consider Italian bonds as a good proxy for spanish bonds but i am not comfortable with considering french bonds a proxy of germans
how about buying the spanish bond through a european brokerage and short the equivalent in German bund futures ?
About the repo , a repo usually works that way, you borrow money against collateral , a bond for ex., what happens is you sell that bond , get cash, with an agreement to repurchase (when the loan comes to maturity) , you then repurchase the bond at a higher price reflecting the repo rate (of interest). It seems we are talking about a different kind of repo here , right ?
Anyway like one poster indicated , a trade like that not only is complex to implement but involves a number of risks. What could actually happen is a widening of the spred , you would get screwed on both ends. If you really believe spanish bonds are value, then you could just buy them outright and hold to maturity if the spread widens.
