Home Forums Main Forum "Always have your book be long carry and crisis"

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  • Curve Advisor
    Keymaster
    Post count: 612
    #515 |

    I used to to work with a guy (“AG”) who made $100 million almost every year like clockwork. One time, he gave us a talk on plotting all of his trades on an axis, where one axis is crisis and the other axis is carry. He had like over a dozen examples from his book listed. His point was that AS A BOOK, your trades should always be long carry and crisis. This is completely different from being just outright long rates. You can be bearish rates and still have a book that outperforms on a carry or crisis scenario. It’s fine if individual trades in your portfolio are short carry or short crisis – this is just a guideline for the entire book.

    What is carry? Carry is basically just being able to make money if nothing happens. At the time, he was big on front-end basis swaps, being long equities, long certain metals, long certain FX carry crosses, etc. He had a very wide variety of different types of trades. Most days, nothing really happens in the markets. Collecting a little something every day makes a lot of sense. For every economy like the US and UK that are moving along, you have one like the EU or Japan, and many countries in between. You can always find something somewhere, whether it be rates, fx, commodities or equities.

    What is crisis? Crisis is just any kind of big shock to the system. This could be a financial crisis, terrorism, shocking economic data, whatever. Sometimes these events happen at unexpected times. You should always be prepared, because most of the time, the markets give away crisis protection for next to nothing.

    In subsequent posts, in this thread, I will expand on this idea.

  • Curve Advisor
    Keymaster
    Post count: 612

    Some of you may be thinking, “man! he must’ve gotten crushed in 2003 and 2004, when the FOMC started raising rates.” Nope. I don’t recall exactly, but I believe his book performed even better on the selloff.

  • mjaws
    Participant
    Post count: 4

    What was his process for identifying reasonable carry trades? How did he manage his risk b/t his crisis protections carry trades and other positions?

  • Curve Advisor
    Keymaster
    Post count: 612

    Sorry. I did not see this post until just now. In a nutshell, he was a slightly unorthodox, out-of-the box thinker, and liked to think about a wide variety of markets. So I do not believe he sifted through the data or price history and built some kind of “screen.” He was more fundamental and macro-view driven, and he had an opinion on a wide range of products. Some of his trades even had multi-year horizons. But when you have as much diversification and carry as he did, it was fine. When you find a product you have a view on, you just ask yourself what happens to the trade when nothing happens.

    He implied he had a good sense of his risk mentally, which was kind of hard to believe. But he was obviously very intelligent, and not because he was consistently successful or he had an advanced degree. And I suppose when you look at everything in carry vs crisis quadrants, there are some quadrants you don’t have to think about as much, depending on the environment you are concerned about. I believe his did make some macro-adjustments to his book, if there was something coming up. Also, as a back-up, JPM did have a risk department that ran a daily VaR simulation. So occasionally he would get the tap on the shoulder and he would have to go talk to management, but he was given good leeway.

    I think I answered all your questions. Let me know if I didn’t.

  • Curve Advisor
    Keymaster
    Post count: 612

    Umm… Yep. A few weeks after I wrote this, getting a bunch of that “free crisis” risk protection in your book doesn’t seem so bad. My implementation left something to desired tho… as I am still a little confused by the bull flattening on the big rally. But I would rather be me, than the guy holding the other side of this position.

    Next week should be really interesting.

  • Curve Advisor
    Keymaster
    Post count: 612

    The conditional bull steepener ended up doing well, but not as well as I thought. In any event, always have crisis protection – especially since it is usually underpriced.

  • Curve Advisor
    Keymaster
    Post count: 612

    I mentioned in the CA newsletter a week ago that the markets feel like they want to trade in a tight range for a while. Then it made me think of this thread. One of “AG”‘s favorite trades was to receive 3 month libor and pay 1 month libor. For some reason, the swap was consistently “mispriced” (where it was close to flat). I suppose this could happen when enough customer flows consistently go the same way. This was a consistent money-maker in *almost* all scenarios… expect at the start of the Great Recession, and was probably one of the main reasons his fund blew up in 2008. You would expect the 3 month and 1 month libor to invert if the Fed has to ease aggressively. I am assuming whatever hedge(s) he had for the aggressive ease scenario did not kick in.

    But the idea of having on some trades in your book where you make money on a non-event makes a lot of sense. People tend to always think about positioning for something “happening” – whether you are playing for a hike, or QE, or strong/weak data, or whatever. However, MOST days, absolutely NOTHING happens. So rather than just planning for the 20% of days where something happens, also have a plan for the 80% of days where nothing happens.

  • Curve Advisor
    Keymaster
    Post count: 612

    I have been thinking more about what to write in the new “Basics” section. One of the main reasons the typical small investor SHOULDN’T trade futures is because it’s a negative sum game (for you to make money, someone else has to lose money, and you both have to pay transactions costs). This is why it is very important you have some positive “carry” in your book. Now with most futures, there is no carry. It’s not like a short term bond, where you get money eventually. You also don’t get dividends, or interest rate differentials, or anything! But there are some ways you can try to create some “carry-like” P&L:

    1) OPTION DECAY. I’m sure all of you know Bill Gross – he was probably the largest trader of futures at one point. But one of his main positions was to constantly sell straddles and strangles. Even when he said “bunds were the short of a lifetime”, his main position was being short a lot of calls vs being short fewer puts on bunds. That’s how he got “short.” I’m not saying selling straddles or strangles is a great strategy. This could crush you at some point. But part of his “new neutral/normal” view was that the long end was just going to sit there for a while. Not only did he make money on carry with his security holdings, he also got a lot of decay off of his options trades. This takes a lot of experience – a good understanding of; (1) what is going on in the markets, (2) when vol is rich or cheap, and (3) when the tail risks are great.

    [to be continued]

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