Archive for July, 2008
IR Steepeners and other stuff
Yesterday’s change in US LIBOR was not that notable. but the trend that I see is to the gap between the 12M and the 1M US LIBOR is narrowing, indicating a flattening of the curve. I’ve only looked at the last 5 days and I’ve seen a 13bps flattening since then. Flatteners right now would probably be a good idea. So go long short-term IRS and short long-term IRS.
The S&P is at Summer 2006 levels and not showing much sign of relief. Stocks in Europe have been falling and for the fourth day, the MSCI World Index has shown a decline, on concern of that credit losses will worsen and the economic slowdown will cut earnings. According to BBG, US Index futures were little changed. I talk with my colleagues about shorting the XLF ETF. See, we can’t trade single-name stocks because we work for a bank so we have to talk in terms of ETFs, which have depressed volatilities because they are closed-fund, baskets of stocks. BBG says that $11 trillion has been erased from global equities in 2008 alone. Looking at both graphs for the same time period, you see almost exact trends when compared to the S&P.
I am almost finished with Reminiscences of a Stock Operator and have been thinking what would Larry Livingston do in this situation? Definitely its a bear market, but how would he trade rates steepeners/flatteners? I say that there is a downward trend moving IR curves flatter due to the continued market volatility and general sentiment that there is still more pain to be felt. But that’s just my opinion. Unfortunately, in IRS the market supply is based on counterparties willing to trade and not actual number of contracts available to trade because contracts can be created at any point and time. So it only depends on the market that your counterparties or market makers you solicit when wanting to trade IRS. Fortunately, the IRS market is very liquid so putting on 20mm long 3M and short 20-30MM 12M probably wouldn’t be hard. Plus, I haven’t looked beyond the year horizon and I’m sure that the desparities between 3M and 5Y and 5Y and 10Y are more significant. Its probably more exciting to trade within the year horizon anyways putting on and unwinding trades on a daily basis. Going long and short Treasuries is an option too. It proabably comes down to funding and if the LIBOR funding rate established in the reset is less than your funding rates, then its probably a good idea to trade IRS instead of Treasuries to eek a couple more bips from paying less funding. But then you probably have to give up some collateral if not funding so its probably a wash anyways. What do you think? Good ole’ Larry Livingston didn’t have to deal with these issues too much but the book did talk about funding positions a bit and how there was some manipulation of the money market that brokers and traders used to fund their operations during that time, which was called the Money Post at that time. Things are a bit different now. But the concept is generally the same. The cost of funds is just the money you pay to borrow the money spent to go long and paid back after going short or selling out of your positions - or out of realized pnl, cash profits.
I guess my point is that the market is still on its way down and going short equities overall (short financials, homebuilders -what left of them, long industrials and oil stocks) and long IRS flatteners might not be a bad strategy until things start looking upwards. I’ve seen a lot of money lost in steepeners so its obvious there are a lot of folks out there that believe things are turning around soon, but I disagree. I think we still have a good 6-8mos for things to simmer down and get back in the black. The problem I believe is that there is more nearterm uncertainty causing the short-term points of the curve to come closer to the long-term points, and not a true flattening of the curve. I am not a professional “Bottom Caller” and Accrued Interest, a blog I appreciate and enjoy reading, mentions shorting XLF. It might be too late to short but I do agree that at some point I would need to cover. I think that horizon is months down the line. There may be some bumps in the road as the govt tries to bail people out and create soundbites to help calm the markets, but generally, my feeling is that there is still pain to be felt. Its just a hunch and my general sentiment based on what I hear from folks I know in the markets and from what I read - and even Larry Livingston had hunches not based on any quantitative evidence, but just a hunch, a feeling. Hedging that hunch would be a steepener position as they should be pretty negatively correlated, since the primary source of most of the world’s market woes lies in the financials. As the financials worsen, the LIBOR curve should “flatten” out (not a true flattening as I said before) as the market starts to also worsen. So you should gain on the short XLF position and lose on the flatten of the LIBOR curve. To speculate on the betas, adj risk exposures as needed on the XLF after you have laid down a nice steepener position between the 3M and 1Y LIBOR points because transaction costs should be cheaper on trading equity than trading OTC swaps. If you can swing a good line and are confident enough, then screw the relative value trade and just go short XLF and a heavy flattener, assuming that there is a couple buckets of shit left to hit the fan and that the differences between what banks will fund on the 3M and the 12M horizons will get smaller and smaller.
Typically, the LIBOR curve will steepen upon recession, flatten during good economic times, and become inverted upon stagflation. I think the result will be a mix of these factors but overall, the long-term points may shift upward while the short-term points will shift further on uncertaintly and stagflation, so overall it will appear to be more of a flatten than a true steepening that we are used to seeing when we are in a recession.
Anyways, gotta run. I have to get back to work. check ya later.
Back for the Attack!
Holy shit its been a long time since I posted anything to this blog!
Long-story-short, I had some serious family issues that I had to deal with and then couldn’t study for the exam during May. Its basically pointless to take the CFA if you can’t study during the month of May so I cut my losses and decided that I would retake level 2 next year.
So things have changed a bit at work too. I’m working for the prop desk now, which is definitely cooler than the flow desk. Getting signoff at the end of the day is exponentially more complicated but its a healthy challenge and a good experience. I’m actually forced to think about stuff before saying it because somehow or another prop traders actually know what they are doing. Its a bit different from getting signoff from the flow traders I was working for. Now its more like, “why do I have FX pnl on so-and-so curve and what is my overall GBP exp, blah, blah, blah” rather than “am I up or down on equity? credit? ok, cool. yeah, i’m good.” And then they still think their shit doesn’t stink. Meanwhile, I have to explain to them the effects of the NPV of a CDS trade when the 10yr treasury just moved 20bps when credit spreads didn’t change. hmmm….let me think. What happens when the discount rates of future cash flows changes dramatically yet the actual cash flows don’t change….does the NPV change? Um..yeah. I mean, if treasuries just rallied 20 bps do you have to remark the seemingly 100s of Ford or GM bonds you have in your book? Um….yeah. Those too. I really don’t know why flow traders get stressed at all. All they really have to do is keep the books risk neutral, adjust as necessary and fill those orders from the sales traders. I know I’m simplifying things a bit but most flow traders need to stop acting like they are too cool for school when they can’t even keep up with their mini-books and their mini-speculating and their mini-cocks. That was a little harsh, but I’m really just lashing out on maybe 1 or 2 guys that I used to work with (or they would like to say FOR most likely). And you don’t know who you are! Figure out how changes in Treasuries affect future cash flows and get back to me and maybe I’ll take it back. Not all flow traders are idiots, but its always the bad ones that spoil the bunch. I’m not a know-it-all, but if you can’t do your own pnl, then you shouldn’t be trading.
So yeah, things have changed a bit and in a good way. New job, new outlook, and another fucking year until I take the CFA level 2. I hope you find the posts as aMusing as I do. Its just fun, really. Hopefully in the future, I’ll actually post more regularly than banks are collapsing. We’ll see.