I’m a big believer in adjusting to what the markets give you. One of the ways we may get some relative value trading opportunities is when we see large flows that distort the curve. The premise would be that these positions would need to be unwound eventually – either from taking profit or stopping out. Even if they do not, we may be able to find a structure that is superior for the same view as the large flow.
Since some of the volumes have been eye-opening, I wanted to look at the changes in ED and FF contracts since the end of 2017 and the same period a year ago. We know that there has been large buying in EDZ8-Z9 spread (ED4-ED8 spread). We also know there has been opposing interest in selling the ED4-8-12 fly (albeit just that one time for 100K). What I find most interesting from the Table on the right (listing changes in OI in generic ED and FF contracts in the past two weeks and past year) are:
- The ED8 change in OI is even larger when compared to last year. Someone out there really loves the EDZ8-Z9 spread. The OI on EDZ9 is 1.317 million, while the average of EDU9 and EDH0 (the two contracts surrounding EDZ9) is only 692K. 600+K is a massive difference! It could be the Z algo, but just from past observation, the Z algo should be at their max position. So there may be additional interest out there.
- We’ve seen some earlier 2019 hike interest. The large change in red pack (ED5 through ED8) OI from last year indicates more interest in deferred hikes 1 year out. I do think this is becoming a “popular” trade, with less than one hike priced in. This could make sense on an absolute basis, since less than 1 hike is priced in for 2019. I have no strong view, since on a relative basis, 2019 looks high. I think if the curve keeps flattening, 2019 could be taken out, and eases could be priced.
- Playing for early 2019 hikes may be better than later 2019 hikes. With the curve flattening further out the curve, I could see the appeal of dipping one toe into 2019 via the March 2019 meeting, than to try and position on the entirety of 2019. We have seen interest in buying structures like the EDZ8-H9 spread for size. This, along with the EDZ8-Z9 buying has been putting upward pressure on EDZ8.
- I could have sworn that someone was accumulating a large long position in the golds, as the golds have seemed bid relatively for most of the year. You can see this from how the flies centered around the golds took a nose-dive. Strangely the increase in gold pack OI has been more muted than I thought. Sometimes what you don’t see could be as interesting as what is seen. I’m wondering if this is some kind of spoofing. Let’s keep an eye on it.
- The most interesting flow is in FFF9 (FF13). Last year, the OI was only 47K contracts. This year, it is 157K contracts. That is over 3x last year’s OI! Part of the reason could be that the choppiness of libor has caused people to drift out to FFF9 rather than EDZ8 for 2018 hike plays. But what goes in must come out.
We have on some relative value trades that try to take advantage of some of the above. But I also want to plan around some of the larger market participant positioning.