[Trade F1, January 6, 2016]
When there is more uncertainty in the world but there is more specificity on the curve, I think you have to fade that.
Sell EDZ6-Z7-Z8 1yr fly vs Buy 2x EDZ7-Z8-Z9 1yr fly @ 6.5 (7 settle)
Alternate: Sell EDH7-H8-H9 1yr fly vs Buy 2x ED H8-H9-H0 1yr fly @ 6.5 (6.5 settle)
There was an unfavorable settle in Z7 1 year fly, but the settle in Z6 1 year fly was slightly low as well. You can get a much better fill if you can buy 5.5 in the Z7 1 year fly (trading small now). Reasons to do the trade:
- This is the two year high. The mass on the top is the data from last year and the mass on the bottom is from the data two years ago. I think this is here because the bears probably like accumulating shorts and steepeners thru the reds. For now.
- Fundamentally, this does not make sense in light of the events of week 1 of 2016. We just got through reading the Minutes, where the Fed has made clear they are going to be very cautious. To try and price in relatively more hikes in the reds while everyone is trying to buy the long end makes no sense. If anything, a continuation of recent events will take out near-term hikes and push hikes in 2017 further out the curve, which would be great for the trade.
- This was negative just 5 business days ago. The Dec average post the FOMC meeting was -0.7. So we would look to make about 5bps on the trade.
- In Euribor, the similar structure is at -10. I just want to highlight that in a “central bank on hold on a flat curve” scenario, this is what the curve could/should look like. The flatter the curve, the less shape it should have.
- This has positive roll forwards and backwards. 6 months earlier, the structure is -6 and 6 months later the structure is 3.5.
The main caveats would be that this structure may not work well if the year flies go (significantly) negative, as it did three years ago. I don’t see that right now with the flies all being so positive. And on the path there, we may make money before we need to exit.
[Originally sent to CA clients Jan 6, 2016. Profit taken Jan 8]