Let me 'try' this One thing though - If you have been trading the spread for some time you should know this !!!! Euribor is UNSECURED and therefore represents a risk. Schatz is government debt (therefore expected to be risk free) if you 'neutralize the duration' as you call it - I assume you mean you trade the Euribor with an expiration as close to the expiration of the Schatz than basically you would be trading the risk appetite / nervousness in the market. Most people I know who trade this spread however do not trade the Euribor contract with the closest expiry to the Schatz as this contract is not very liquid - instead they trade a more active contract... for example a contract from the 3rd white to first red (around 1 year out) This way you have both the 'risk' trade as well as the difference in expiration (curve trade) which makes the trade more volatile... There are many ways of looking at this, but hope this is a starting point..
EURIBOR/Schatz trade is just one special case of a category of relative value trades that involve expressing a view on 'swap spreads', aka 'asset swap', aka just 'spreads'. Generally, in the world of rates, these types of trades involve buying/selling a bond (or repo or derivative, such as a future) vs selling/buying a DV01-weighted amount of an IBOR derivative. A position structured properly this way (both outright and bucketed DV01s exactly offset) doesn't expose you to any outright rate risk or curve risk. The PNL on such a trade stems solely from the changes in relative pricing of govt bonds vs IBOR. These changes occur as supply/demand for bonds fluctuates. These fluctuations can occur due to govt bond issuance shifts, changes in risk aversion/seeking behavior of investors, etc. There's all sorts of other things I can talk about as these trades are very fundamental and have a lot to do with the functioning of the money mkts. However, I hope my initial short summary helps answer your question.
How to properly structure the schatz/Euribor trade (also, in answer to a question on another thread). This trade is also known, somewhat confusingly, as a EUR TED trade. For every 1000 Dec Schatz contracts bought/sold, you sell/buy 108 lots of each Euribor contract, starting with the fronts out to M11.
Sounds (and it is) quite logical. I ideally pick up 4th or 5th Euribor and trade it against Schatz. The duration neutral spread b/w Euribor and Schatz (Euribor minus Schatz) has been slowly crawling in the downward direction. Does it, by any chance, indicate the improving market conditions?
This is not duration-neutral at all... Duration is not the same as time to maturity/expiry. If you don't price the spread correctly, you're going to end up with all sorts of risks other than the spread that you're trying to trade. Which, in turn, means that whatever moves you're observing are caused the things you're not interested in trading.
That is right. I personally hedge 10 Schatz with 6 Euribors!! Well, you were right when you said that I should know the logic behind the trade before starting it. But anyways, its better late than never. The hedge ratio here is 1000 Schatz V/s 650 Euribors! And the logic, like you said, is to equalise the DV01s of both the contracts and trade against each other! Could you please link me to a thread which explains the calculation of DV01s of both the contracts? Many Thanks. Chintan Thakkar
If you don't price the spread correctly, you're going to end up with all sorts of risks other than the spread that you're trying to trade. Which, in turn, means that whatever moves you're observing are caused the things you're not interested in trading. [/B][/QUOTE] Is it possible to execute 6 x 108 Euribors and 1000 Schatz simultaneously? I haven't tried it before! Whats your take?
I agree it is very important to understand this difference. I described this in my reply as - 'I assume you mean...' as this is a common mistake people make. (especially non-natives.... and I have to admit that when I started trading this was very confusing for me as well) I was hoping this would help OP to re-think his wording (understand the basic concept of duration)
Using an autospreader this is possible, but you may be giving up some edge as the machine usually only works 1 leg and than hit/ lifts the other leg(s) - I have also worked with a spreader that will 'work' the second / third etc leg, but found that the logic when to hit / lift in case the market moves was not as good as I wanted.. Especially when trading a fast market (this is usually when opportunities arise) this can be a problem... Most people I know, take some directional risk by legging into these kind of positions. Also, the Euribor side can be traded in one by using packs, strips and bundles... However,please note again that others are likely to answer better on this (from personal experience) - I have not used these much in my trading..
There's a couple of threads here that describe how to calc simple DV01 for bond futures (I think I posted a Eurex doc and atticus kindly provided a link to a CME doc). For Euribors, DV01 is just â¬25/bp. It's certainly possible. You can do all sorts of executions. I agree with this, H2O. There's always a trade-off between difficulty of execution/slippage and the amount of residual risk you end up running. This is exactly why trading is not quite a science. A trader's job is to optimize this tradeoff, subject to a variety of constraints. I might add that the proper way to express a view on Schatz swapspreads is to buy/sell the Schatz futures vs paying/recving on a fwd-starting (out of futures maturity date) IRS with maturity that's equal to the maturity of the CTD.