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STIR & Bond Spread Thread
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Created: by CobblersAwls Attachments:3

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STIR & Bond Spread Thread

 
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STIR & Bond Spread Thread

I thought I'd start a thread that looked primarily at STIR markets (Eurodollars, Short Sterling, Euribor etc) as well Bonds too.

I'd like to start discussions on trading spreads and packs in the STIRs as well as how STIRs can be combined with Bonds to create spreads such as the TED spread. It would be great to learn more and discuss educational topics around the subject as well as trade ideas and theories about what combinations work well and why.


I know a bit about the ED market, but not enough, so would like to start with this question;

"Treasury Eurodollar futures spread trades are common in the market and carried out regularly by banks and proprietary traders. There are two main reasons why such trades are undertaken. They are:

- when traders need to hedge their Treasury interest-rate risk against a change in yields;
- when speculators anticipate a change in the difference between the Fed rate and the London inter-bank market."


Traditionally, the TED spread was done between treasury bills and eurodollars, but has evolved to include trading against 2-5yr notes. How does that work exactly and what are the traders trying to achieve when doing so?

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Quick Summary
Quick Summary Post

Informative Papers:


Yield Curve:

Yield Curve Spread Trades (Bonds)- https://www.cmegroup.com/education/files/yield-curve-spread-trades.pdf
Curve Advisor (STIRs) (Part 1) - http://www.cmegroup.com/education/files/curvature-trading.pdf
Curve Advisor (STIRs) (Part 2) - http://www.cmegroup.com/education/files/curvature-trading-parttwo.pdf


TED Spread:

http://kawaller.com/pdf/tedrev.pdf
http://www.yieldcurve.com/Mktresearch/files/Nematnejad_TEDwebsiteJan03.pdf


Last edited by CobblersAwls; June 21st, 2018 at 08:13 AM.
 
 
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CobblersAwls View Post
If you would like to look at some interesting spreads in the Eurodollar market, may I suggest checking out some of the spreads around 2019. Z8-H9 has been trading negative, implying that the market is pricing in lower yield in March 2019 than December 2018. Some speculate this could be due to a recession, perhaps it has something to do with the Z turn? Who knows. It's a terribly complex market - good luck.

Anybody here able to properly explain how to calculate the turn? I've tried to calculate the implied turn from the Eurodollar market and I get some very inconsistent results.

For those unaware, "The Turn" refers to the effect that year end short term borrow rates are slightly higher than other periods due to a higher than expected funding need, to make year balance sheets look better. If you plot butterflies you will see kink in all the curves around Z.

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Notes on 'The Turn'


SMCJB View Post
Anybody here able to properly explain how to calculate the turn? I've tried to calculate the implied turn from the Eurodollar market and I get some very inconsistent results.

You may have already come across this thread, but Joseph Choi discusses it in some detail over on his thread (https://www.curveadvisor.com/forums/topic/what-to-use-for-the-z-turn/). I'd recommend reading through it, but some key points are:

"There is a bit of chicken and the egg going on in the pricing of the Z turn. You can try and estimate what the year-end funding pressures are going to be, or you can try and infer it from the shape of the curve. Typically, people use one to infer the other. If you are a short rate market-maker, you may see flows that give you an idea of flows. For the rest of us, we have to estimate this from what is being priced into the curve."

"The curve does not always “have to” be smooth. There can be cases where there can be some severe kinking in the curve, if there is some news that affects a particular date (i.e. Y2K, Fed guidance, Fed dates, etc.). However, all things being equal, you would expect the yield curve to be smooth, because the curve imbeds liftoff and hiking probabilities, and you would think the probability distributions (as well as libor spreads to FF) are reasonably smooth. However, you should always ask yourself if it makes sense that a particular part of the curve should be smooth or kinked."

"if you take a probabilistic interpretation of curvature, the curve should be “smooth”. So you are trying to find the turn values that would smooth out the kink in the curve. However, I’m not sure if fitting "these three points to the black dotted line” is the best way. So this again is one of those areas where you can put as much (or as little) work into it as possible:

– I have a preference to use the 3 mo fly curve to look at the turn – I feel like you get more granularity. There is also info in the 6mo fly curve, but it is harder to interpolate off of that, as every other 6 mo fly is affected by two turns – both M-Z-M and Z-M-Z have two turns.

– You can use anything from “eyeballing it” to creating a complex model to back out the turns. I don’t think there is any “right” answer – use the method you feel most comfortable using. I think when you look at 3 mo flies, you are focusing on a small enough area where you can attempt to fit adjacent flies to a straight line, with a reasonable enough error margin.

– You can use multiple methods. For example, you can use your calculation method of choice, and then manually adjust if something does not seem right to you.

– You can also use data from the libor cash fixings (as well as overnight index swaps, or other short term vehicles) for the front turn, although it is subject to some noise. For example, if the markets are quiet, you can periodically see what happens to the cash fixings as they go over year-end. This could be a useful comparison point if you use constant turns throughout the entire curve (you adjust all Zs by the same amount).

– You also have the option of using different Z adjustments for each contract year. This is my preference, and I will discuss this further in another post."

 
 
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CobblersAwls View Post
You may have already come across this thread, but Joseph Choi discusses it in some detail over on his thread (https://www.curveadvisor.com/forums/topic/what-to-use-for-the-z-turn/). I'd recommend reading through it, but some key points are:

"There is a bit of chicken and the egg going on in the pricing of the Z turn. You can try and estimate what the year-end funding pressures are going to be, or you can try and infer it from the shape of the curve. Typically, people use one to infer the other. If you are a short rate market-maker, you may see flows that give you an idea of flows. For the rest of us, we have to estimate this from what is being priced into the curve."

"The curve does not always “have to” be smooth. There can be cases where there can be some severe kinking in the curve, if there is some news that affects a particular date (i.e. Y2K, Fed guidance, Fed dates, etc.). However, all things being equal, you would expect the yield curve to be smooth, because the curve imbeds liftoff and hiking probabilities, and you would think the probability distributions (as well as libor spreads to FF) are reasonably smooth. However, you should always ask yourself if it makes sense that a particular part of the curve should be smooth or kinked."

"if you take a probabilistic interpretation of curvature, the curve should be “smooth”. So you are trying to find the turn values that would smooth out the kink in the curve. However, I’m not sure if fitting "these three points to the black dotted line” is the best way. So this again is one of those areas where you can put as much (or as little) work into it as possible:

– I have a preference to use the 3 mo fly curve to look at the turn – I feel like you get more granularity. There is also info in the 6mo fly curve, but it is harder to interpolate off of that, as every other 6 mo fly is affected by two turns – both M-Z-M and Z-M-Z have two turns.

– You can use anything from “eyeballing it” to creating a complex model to back out the turns. I don’t think there is any “right” answer – use the method you feel most comfortable using. I think when you look at 3 mo flies, you are focusing on a small enough area where you can attempt to fit adjacent flies to a straight line, with a reasonable enough error margin.

– You can use multiple methods. For example, you can use your calculation method of choice, and then manually adjust if something does not seem right to you.

– You can also use data from the libor cash fixings (as well as overnight index swaps, or other short term vehicles) for the front turn, although it is subject to some noise. For example, if the markets are quiet, you can periodically see what happens to the cash fixings as they go over year-end. This could be a useful comparison point if you use constant turns throughout the entire curve (you adjust all Zs by the same amount).

– You also have the option of using different Z adjustments for each contract year. This is my preference, and I will discuss this further in another post."

That's where I got stuck about a year or so ago. Joseph Choi takes you through how to manipulate data from sources such as Quandl to allow for the turns etc on his forum, but my charts never quite looked like his.

 
 
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Potential Idea - The Turn

@SMCJB and @adam777

I've been mulling this over and have come up with one way of trying to identify some of the premium baked into the turn. Let me know your thoughts and if you think I may be close but not quite right, or just plain off the mark.


(Edited to Add) If we can assume that EDs are Fed Funds + libor spread + counterparty risk premium, and the turn risk appears in the Fed Funds and bleeds into EDs, could we try and isolate that somehow by spreading EDs vs FFs around the turn?

Given that spreading EDs vs FFs is done like so:

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(FF are 30day rates, EDs are 3m hence different dates)


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Firstly, the 'Spread' is the ED price vs an average of the 2 FF prices.

The Z-Turn bps is the premium around each Dec contract, for example, for Dec 2019 where the Z-Turn is 3bps, it is calculated by spreading the 'Spread' around it (U19-Z19-Z19+H20).

Thoughts?


Last edited by CobblersAwls; June 26th, 2018 at 06:31 PM. Reason: Added a note on reasoning around this
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CobblersAwls View Post

Thoughts?

Now that forward curve looks interesting ... I need to put all this into excel and have a look at it.

Quick article talking about trading (or surviving) the z turn.

https://www.google.com.au/amp/s/seekingalpha.com/amp/article/4134111-return-year-end-eurodollar-futures-turn

I get the sense that you need to be a big fish trading ED vs FF, after looking through Curve Advisor and the Eurodollar handbook


Last edited by adam777; June 26th, 2018 at 11:00 PM.
 
 
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adam777 View Post
Now that forward curve looks interesting ... I need to put all this into excel and have a look at it.


Do you have access to ED and FF historical data?

Would be good to dump data into a spreadsheet for around December 2017 and we can check to see if the adjustments would have worked somewhat.

 
 
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@CobblersAwls and @adam777 I've been travelling for two weeks. Give me a couple of days and I'll be back.
Really interested to get into the Z Turn Discussion.

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