I have given some further thoughts to those who are making the spreads on yield curve. People seem to think mainly in the difference between yields, but I think that when the interest rate on the short time frame is low, the pricing of the spread might also be a function of the ratio of the yields? I am not clear about this though. Does anyone know more about this? I believe one of the dangers is from the short end, and the mark to market as it relates to a draw down. Could the the spread's price may be "under-valued"? So it is possible that Bone/Martinghoul/others could be right in their views on this carry trade, if shorter term interest rates stay low, and one can hold their positions. It needs further thinking....
Let us give bone some credit on his view on 10-years some Friday ago. It went higher than it was at, at the time, and he deserves the recognition for it. One should give credit when credit is due! Bone: Have you thought about giving some examples of how you look at spreads? Would it help people inquire more about your services? Just some questions in case you would find them useful.
A profit is a profit is a profit... Flatteners are a gift that keeps on giving, but you have to pay the negative carry. The trick is finding the right curves and the right places on these curves, such that the risk/reward is good enough to justify the carry. In concise summary, that's why I don't like your trade, Big D: risk/reward is not good, especially if you consider all the tail risks, to make me want to pay the negative carry/rolldown. I aslo don't see any catalysts that would make the trade perform, as I haven't seen any evidence of the whole "speculators are excessively long" story. That's just my opinion, obviously, so take with a grain of salt. tj, it's got nothing to do with yield ratios. Before you can meaningfully theorize and make educated guesses, I think you should read some books/papers that explain the fundamental mechanics of the bond mkt.
Ah, the two village idiots again. Welcome to the world of fixed income with its charming syntax. Basis is one thing with 'clean' and 'dirty' prices but options are on another level entirely. If I had said "out of moneyness" instead of "beyond the money" it would still have meant no difference to you. Whatever you do, never pick up a phone and call a bond future options desk on the floor of the Board for an iron fly quote or a dealer in Houston for an LN strangle quote. Not a retail guy in Delhi - a floor operations desk. Hell, you wouldn't even know how to quote the strikes on an options spread. I'm bullish rates in May, but I'm unsure of time horizon (that's theta) and want some downside protection so I buy a Ten Year Bull Call Spread 18 tics out of the money (to simplify for you, after 18 tics the front strike in the vertical spread [you know, the long one] is known to be in the money ITM). It was great timing, because June was pretty close and I could get Sept without going to the Flex market, but I digress. (go ahead, quickly Google the flex market) Long story short, we rally through both strikes (again, to simplify for you, the second strike in the vertical spread is the short call position which we sell to limit our downside risk and minimize the theta (thats time) component. Did I mention that the first strike is the long call leg that's deep in the money by now? OK, so, well, we keep rallying!! But you know what? My position doesnt earn any more money as it continues to rally past the second vertical strike (the short leg) - no more moneyness. beyond money. yep, that's what its called. it can rally to the moon and it keeps a very slight net positive delta but never keeps its value. What do I do with that slight positive net delta? I do what we call a horizontal spread - I sell a higher strike in the Dec contract, but since that strike price is still a few points higher, in the business we call that out of the money, or OTM. Using the profit from the Sept. bull call spread I sell enough Dec 130 deltas to cover the slight delta risk and gain the vega (thats the volatility part, google it real quick) and theta (we talked about that, that's the time premium component). As a side note the timing for the Dec 130's is great because the premium three months out is really fat, but again, I digress and confuse the two idiots again). So, the short hairs of it is that if we rally to 133 in Dec Tens I start losing money on the whole affair. So, at this point I am now realizing how utterly fruitless it was to explain anything to these two idiots. Oh well.
I call those things call ladders, bone (although, to be fair, I refer to all same expiry options), and I once had a close shave on one of 'em (it was in the bobl during one of the Dubai episodes). The experience left my psyche permanently scarred and I swore to never ever do crap like that ever again. It's one of those things that looks good when you put it on, but I won't quickly forget the horrible sinking feeling you get when you go through the second strike and then through breakeven.
Mart: Well, mine is a crooked ladder because it sure didn't start out that way - I just got cute with the profit and whisker-thin delta thinking 'no way no how that's fat premium what are the chances we get there anyways' on the Dec 130 strike.
Yeah, I know. While the theoretical downside can be just as painful, if you have enough cushion, you can make it sufficiently distant to allow you to hold on without excessive clenching of buttocks. Still, as I mentioned in another thread, I ain't never going short gamma. I can find much more entertaining and pleasant ways to get my ass handed to me in the mkt.
Well, of course, the Sept position is a non-issue by now, and if we continue to rally in a methodical fashion it will be somewhat tolerable because the theta on Dec really pays off hard next few weeks. If we come off it will be pure sweet tasty goodness - Sept. profit gets compounded nicely with the Dec position. If we reach 130 I start scale buying aggressively because that delta will hit like a freight train.
Option nonsense aside, the move continues as predicted. Sort term the target is 109'160. Depending on how we get there that might move. I'm not surprised to see the Sep/Dec spread has expanded to more reasonable values. That's fine - as others pointed out, it is possible for those with the capital to take delivery to arbitrage the situation, and it had to happen eventually. That's the reason I didn't go long the spread despite the fact that it was trending nicely. The whole point was simply that it was an indicator of who held what positions. Now every speculative long entered for the last two weeks is under water. And I don't see any evidence of funds buying - they still appear to be reducing exposure. Going down...
D, you're so defensive and singular in thinking that you're not taking in Marting's comments about curve behavior, and apparently the "options nonsense" flew completely over your head - I'm net short TY Dec 130 calls. I really and sincerely hope you reach your target on your Twos. The big difference is that I would have caught the move both ways with duration that pays off. Twos are off 1.7 and Tens are off 25.0. We can go down another point and the Sept bull call spread hasn't lost a nickel but the short Dec 130's payout accelerates.