The Fed fights inflation AND inflationary expectations. There seems to be a very good buying opportunity in the making. You'll see what I mean very soon, before the middle of March.
I may not be following this correctly, but they're short many more deltas in spot than they're long on the bull risk-reversal. There is significant convergence risk on a grind back to 108. Also, there is no vol-smile, so there wasn't significant $vol edge in the split-reversal.
Euro$ futures are now starting to discount a 5.25% Fed Funds rate. At this point, they are only saying its a small chance, but it is out there. Pretty wierd. I haven't heard anyboy out there talking about 3 more tightenings by the Fed. Curve shorteners may find themselves on the wrong side of some serious volaitility if the economy weakens. Euro$'s could move up 50 pts in a heartbeat.
This trade is delta neutral. I'm not sure I follow what you are talking about, way too technical, can you put it in layman's terms. My understanding is that if we sit here or grind a bit higher the puts will get whacked because they were so well bid today and he is long calls that were cheapened by a bunch as well. Let me know if I am wrong and the implication of this trade being delta neutral on a grind back say 10 ticks higher.
Okay you guys got me looking at the 10yr bond. I see a distinct pattern suggesting a break into the lower 105 area this month. This coincides with the 30yr dropping to 110 mentioned earlier today...
MC -- it's neutral if traded 20x30[k], futs x options. A 1-handle risk-reversal is only carrying 70d or so with the notes mid-strike. 20k short futures offset by (30k*.70d=21k) futures equiv long reversal exposure. It's neutral here, but there is bull-convergence-risk[bleed] -- as the notes rally they lose more on the futures than they gain on the reversal. It becomes "shorter" as time passes, under one std dev. The trade is long curvature on the upside, which accumulates deltas as notes rally, but worst-case is a close at expiration = the call strike. I didn't see any skewed vol on the put strike you mentioned. Assuming there was, it's meaningless in terms of the PnL on the note-collar they've structured. The trade is neutral here, but suffers into the direction of the +curvature[long premium] IF the contract is more likely to be pinned to the call strike. Lose on call, gain on put, lose on futures. There is a modality change in PnL which makes the trade bullish, but it occurs a half-point above the call strike. To summarize: they need a creep lower or a blowout to the upside > one standard deviation.
Riskarb, Thank you, so if we sit here and maybe trade back up to 107-20 or so and chop around there for awhile then back to 107-10 they are probably in good shape as 107 vol will get hammered? And when you mean they get "shorter" as time passes are you essentially saying the type of move they need gets smaller (i.e. less volatility) to make money?
The trade is neutral-vol and skew as well. What they earn on the call(put) is lost on the put(call). The call and put trade at equivalent vols, or within a tick of equivalence. IOW, there wasn't any significant edge in the collar, but that's not to say it won't be profitable. There is virtually zero chance of the 40d call and put exhibiting skewed vols. As time passes the PnL will favor a trade to 107, but not much below 106'18 (getting shorter). It reaches its max loss at 108, but goes positive around 108'24. I haven't modeled the PnL, but I'd bet I am close on these b/e points. The position behaves like a bullish long backspread. I have no idea why they traded this position as I see no edge under one sigma. Seems like a waste of paper.