[During the week, I send email updates on any market or trade developments I find interesting.]
Email sent on November 18, 2016 [Flip Note – TIP]:
We had a dip in Z1Z2 down to 14.5 this past week. But it has since recovered. This has been a nice choppy (enough) range for us to flip. The one thing I wanted to mention in conjunction with my previous comment about unfavorable closes is that you can consider selling some U1U2 spread against the Z1Z2 position, if you think you can sell 2 bps higher than Z1Z2. This is the relationship between the two spreads:
So if you can sell this at 2, you should expect this to trade 1.5 (almost definitely) and possibly even 1 (you need to get a good leg). Normally, this would be a hard fill, but you just need someone to uptick U1U2 at the close (and we know there is an upticker around). So if you can sell U1U2 2 bps higher, it’s like taking profit on Z1Z2 a half bp higher (since you will eventually be able to get out of this structure at 1.5 or lower). U1U2 also gives you additional liquidity if you need it.
Email sent on November 16, 2016 [Market and Trade Thoughts]:
It’s hard to have a strong directional view on the curve. I have no idea which direction the next 20 bps are going to go. But that doesn’t mean I don’t have thoughts on the markets:
* In this type of curve, I generally like buying the lowest year double fly (or year fly) near the belly. As I mentioned before, this year double fly has limited downside, rolls positively, and allows for flipping possibilities. But the big thing we are playing for is for the hiking cycle to be lengthened. If this were to happen, the hump of the fly curve would move out. I’m still waiting for Z9 1yr fly to trade 2s for this to be Trade F35, but this chops around.
* I was thinking more about recession protection, but unfortunately, we’ve come off the lows. While I do think there is some value in selling the EDH90 call, I don’t think the Fed Dec skip risk and libor-FF risk is worth it (for the EDH vs 2EH call structure I previously mentioned). I’m mulling over buying 1.5x 2EH 85-ish calls vs selling 1x 4EH 80-ish calls – perhaps if the long end leads a rally some more.
* For the past few days, there has been a rush to sell the long end (usually golds or purples) at the close – they come in in the last few minutes. I’m pretty sure one of the larger participants in the market needs a good close. It looks like it is usually H1-H2 (or M1-Z1 or U1-H2). This could be useful information if you are trying to leg something, or you are flipping something. Watch for it. In any event, I think this is one of the reasons Z1-Z2 traded down to 14.5. I like scaling 1 unit per half bp.
Just because I don’t have a strong view doesn’t mean you don’t. As always, if you want to discuss trades, let me know.
Email sent on November 15, 2016 [Market and Trade Thoughts]:
At this early stage, the markets seem to want to price in a relatively short deferred hiking cycle. I think this may partly be longer end belly buying the the usual suspects (central banks, foreigners, pensions, etc). This does not mean the long end can’t sell off more – just that we may have taken a break. An interesting question is, “does Trump change the story of a lower longer term neutral rate?” It was allegedly a structural story, but I’m not sure if Trump is radical enough to cause a change.
The better data today helped support the front flies. But the story remains the noticeably higher (and increasing) flies centered around H9 and M9. This still is not a great time to fade these based on historicals and with the prospect of longer-end buying, even though the fundamentals make sense. Let’s be patient on fading the fly hump centered in the reds for now.
* With this strong retail sales data, a Dec hike seems more likely. If you are “certain” the Fed hikes, I like buying 2EH 85 calls vs selling EDH 90 calls, it’s currently 1-2, but I want to see if it gets closer to 0 as we sell off. I think the EDH 90 calls could collapse after a Fed hike (assuming ED-FF spreads are around here). But more importantly, this should work well on a crisis (since EDH7-H9 should be << 50bps). This could also work if we just get weaker Q1 data, or there is some negative news around Trump’s policies.
* FLIP – Buy Z9 1 yr fly @ 2-2.5. This has consistently been the low fly on the curve, and there are year flies much higher than this in either direction of it. I think this is a good roll trade. It gives you a very cheap look at the longer end blowing out, or the Fed continuing to be gradual in the face of stimulus. You also have some flipping opportunities, and you can always convert to Z9 1yr double. If enough trades @ 2, I’ll have this be trade F35. Buy 4 of 8 units here.
I’m still looking at some other recession trades. Stay tuned.