Libor is blowing out a little. This, along the treasury SFP revival and OIS drift up, has cut the upside of GE calls by quite a bit. The market seems to be expecting something like 35-40bps for the new libor, current upside for the calls is 20-25bps, around 60% potential gain. Problem is there is a risk libor pulls a siva-jothy and endup worthless. The actual risk of that by dec 2010 seems quite small in my view, because the government would step in and bailout whoever is necessary to bring that back down, the problem is the innate desire to get out of the position once mega volatility kicks in It looks like libor has began to correlate more with european developments, now thinking about what will happen and the correct timing might come in handy. The problem is will be making the right forecast. I'm currently considering, selling the calls and jumping on ZQ dec 2010, while I wait for libor to top
I decided I'm going to swap my GE calls for a Dec 2010 ZQ position. This until it becomes more clear where is the top on libor, then I might come back. The greek situation looks like is going to get worse before it gets better and it should end on a package from the IMF with or without some help from EU countries. The problem is that between now and the package bank wire the fears could increase. By swaping the position I'm keeping my exposure to fed policy but avoiding EU exposure(who wants to be long Greece right now?). I am taking of wipeout risk if the fed were to do something crazy, but I see that risk as much smaller than european worries(next fed meeting should have 'extended period' as speeches from many FOMC voters/visitors supported the language) This might cost me money if libor-OIS is putting a false move and comes down but I'm not in the business to trying to predict what that will do in the short-run, so I rather just avoid it
I can't fault you for unloading those Dec GE calls now, but I'm wondering if you ever considered selling the front month eurodollar contract (or buying OOM puts) as a hedge on Libor blowing out. Also, I'm assuming you're just planning on going long the FF futures contract. Seems to me your trading the risk of libor blowing out for the risk of the Fed jacking rates by 50 bp late summer or fall. Anyways, nice work with the trade. I still own quite a few Dec 10 and Mar 11 GE calls. I even own a handful of lottery tickets - Sept 11 and Dec 11 99 calls, purchased for just pennies.
As far as the hedge goes, it would be too many contracts. I'm not sure I even have the margin. Furthermore, the front usually have something like a small risk premium that I will be shorting and will cost me a few bps everytime(cost of insurance I guess, but I'm not thrilled with that) There is another reason to go long ZQ, according to my math 54 current pricing - 80 theorical price at expiration 26bps profit 4bps of loss in case of 1 hike $1040-$160 Almost 10-1 odds for no rate hike. Its actually better than that because the EFF might fail to avg 50bps in case of a hike, in that case, there could be no loss whatsoever in case of 1 hike. The calls also dont lose anything in 1 hike scenario(assuming a new 60 bps libor, at expiration the calls would be worth 38bps, ),so they are robust too. The calls ROI if there is no hike is around 65%. If there are 2 hikes or 1 50bps hike, the calls endup being worth 15bps a 60% loss, almost 1-1 ratio(65-60), the same thing with ZQ(either make 25bps or lose 25bps). So I dont see much disvantage there As I said, if you think the fed might do something REALL crazy(75bps hike, 3 hikes this year) then the calls are much superior. But to me libor issues are a bigger risk than the Fed going insane. The only thing is, I'm not a big fan of going into NFP reports with a large ZQ position(it seems that the market loves to find a reason to collapse big there, but then makes it all back quickly, so I love to buy right after) but I'm going to have to close my eyes and go I would be happy to hear if my math is correct here
What evidence you have to suggest this?Warsh WSJ oped piece? The guy is out of the voting FOMC side. Check out Greenspan book, he explicitly recommended a .25 small rate hike in 1994 in order to keep market disturbances down to a miminal(or something like that). Heck even the DISCOUNT rate they didnt go berserk, hike .25 bps there to start, and thats an irrelevant rate. I'd say its far more likely it will be .25 and it will be widely telegraphed
Also you are missing that bomb dropped by the FOMC minutes 'we arther be late because we can play catch up later than be early, kill the recovery and not be able to cut rates'. First hike will be .25bps and I'm willing to lay odds in a bet on this
Greenspan's reign on the FOMC is being seen more and more as a disaster for this country. I hope the current FOMC is not paying any attention to the little weasel.
I'm interested in knowing how an IMF loan affects the credit rating of Greece. I recall reading they lend at 2.5%, so I assume that would help the ratings. If they ask for bigger defict cuts that could help too. So assuming they stop the BS about getting money from the EU and go for the IMF they could have a shot a survival