Futures Spreads For Interactive Brokers, LLC January 18, 2007

Transcription

1 Risk Disclosure Futures Spreads For Interactive Brokers, LLC January 18, 2007 Presented by: Kevin Baldwin The risk of loss in trading commodities can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. The information contained herein is derived from sources believed to be reliable. The audience should practice their own due diligence. THE INSTITUTE FOR FINANCIAL MARKETS This presentation has been compiled for general information purposes. Examples are hypothetical, used for explanatory purposes only. Although every attempt has been made to ensure the accuracy of the information, the instructor and the IFM assume no responsibility for any errors or omissions. About the IFM About the Instructor The Institute for Financial Markets, founded in 1989, is a Section 501(c)(3) nonprofit industry-sponsored educational foundation. The IFM is dedicated to providing quality and unbiased information,research data and instruction. The Institute offers independent-study and exam preparatory materials in print and computer-based formats; instructor-led seminars and customized, in-house training; research data; desktop reference tools; and consultancy on industry standards and best practices. Institute for Financial Markets 2001 Pennsylvania Ave. NW Suite 600 Washington DC Tel: Fax: info@theifm.org Kevin Baldwin is the IFM s Director of Education. He began his career in the futures and options industry 16 years ago with Refco's Institutional Applications department that was subsequently acquired by Man Financial. He taught the firm s six week futures and options course in Chicago for many years. In addition to the six-week Chicago program, he provided shorter-term derivatives seminars for client institutions in Buenos Aires, Rio de Janeiro, Tokyo, Seoul, and Moscow on behalf of the British government's Know How fund. Mr. Baldwin also was an instructor for the Illinois Institute of Technology's Master's Program in Financial Markets. In 1996, Kevin Baldwin joined one of Refco's innovative Introducing Broker's in New York City as managing director and has held various securities and futures registrations including Series 3, 4, 7, 24, 30 and 63. In addition to his professional responsibilities, Kevin became an adjunct faculty member for New York University's School of Continuing Education where he taught both Intermediate Securities Analysis and Futures and Options courses. In 2000, Kevin returned to Chicago and developed a portfolio of websites aimed at different segments of the futures and options community.more recently, he has offered an updated variety of in-house 3-day to 3 week futures and options courses to firms. Mr. Baldwin earned a Bachelor of Science degree from San Jose State University in California, and an MBA from the University of Chicago, Graduate School of Business. 1

2 Types of Spreads Intramarket spreads Cost of carry & arbitrage Intermarket spreads Cross currency spreads Intra-market: Inter-market: Same commodity; different contract months Different commodities; same contract month Intra-Market Spread Quotation Cost of Carry Positive Carry: Spread = Nearby - Deferred Negative Carry: Spread = Deferred - Nearby Futures = Spot + (Finance Cost+ other xps Payouts) Cost of Carry = Finance Cost - Payouts Other xps: storage,shrinkage,freight,insurance,etc. 2

3 Correlation Intra-market spreads are generally viewed as less risky 1 than outright futures because of the normally strong correlation between contract months. However, this may not be true. Intra-market spreads may be as volatile or more volatile than the outright. 1 NFA and CFTC regard spreads as potentially equally risky as outright futures. Strong correlation between contract months usually means the profits on the long leg will generally be offset with an equal and opposite loss on the short leg. However, when carry changes, the relationship between the two contract months are likely to change. It is this environmental change from which the inter-market spreader seek to profit. Intra-Market Spread Strategy Stock Basket spreads: seek to profit from anticipated changes in the stock market carry. Interest Rate spreads: seek to profit form anticipated changes in the interest rate environment. Currency Spreads: seek to profit form anticipated changes in the interest rate differentials. Assuming a positively shaped yield curve, bond futures prices can be expected to price at lower and lower levels -positive carry. A trader would buy the spread in the expectation of a steepening yield curve. Similarly, a trader would sell the spread in the expectation of a flattening yield curve. 3

4 Mar/Jun. 06 Bond Sprd = Nearby less deferred = less = 8/32s or ¼ point Initial Parallel Steepening Flatteninginversion 3 mo. rate: 4.50% 5.50% 4.00% 5.00% 20 yr. rate: 4.60% 5.60% 5.00% 4.50% USM6 bond: USU6 bond: Spread: 0/32s 1/32s 9/32s -4/32s 178 days to June delivery 270 days to September delivery Intra-market note spread Jun/Sep 2006 T-Note Spread 2005 to 2006 Selling nearby, buying deferred= Credit spread=sale anticipating a flatter yield curve. Types of Yield Curve Fluctuations Parallel shifts: When yields at the long and short end of the yield curve shift up or down by the same amount. Shape Change: When the yield curve either steepens or flattens. 4

5 E(Ret.) E(Ret.) Yield Curve Steepening Yield Curve Flattening Maturity Maturity Treasury Coupon Curve As the yield curve flattens, positive carry is decreasing. Thus, back months should rally relative front months. Strategy: Sell the intra-market bond spread Spot P x time M6 Post-shock U6 Initial 5

6 Inter-market Spreads As the yield curve steepens, positive carry is increasing. Thus back months should slump relative front months. Strategy: Buy the intra-market bond spread Spot P x time Notes over bonds (NOB) Five year over Ten year Five year over Long bond Euro s over Two year Euro s over Bonds M6 U6 TYM6 USM6 Jun 2006 NOB = less = = -4 pts + 26/32s = -154/32s The NOB is quoted this way (notes-bonds) because if yields > than the 6% convention, the spread will be positive. Now, yields are much < 6% so the spread is negative. Yields Rise: Yields Fall: Buy NOB Long Notes/Short Bonds Sell NOB Short Notes/Long Bonds Whatever you do to the Note is what you ve done to the NOB 6

7 Long the June 06 NOB Spread -positioned for expectation of higher yields ahead Anticipated Shape Changes in Yield Curve Yield Curve Steepens: Buy weighted NOB Yield Curve Flattens: Sell Weighted NOB In anticipation of a parallel Yield Curve shift, the trader may decide to use a 1:1 ratio. This strategy will benefit the trader under the following circumstances: Recall that: Cash ctd = Futures x CF ctd + gross basis As maturity approaches the CTD basis zero Differentiating through the equation results: A Parallel shift up: Buy shorter duration securities, sell longer duration securities. Thus: Cash CTD = Futures x CF CTD Cash ctd Futures CF ctd A Parallel shift down: Buy longer duration securities, sell shorter duration securities. BPV futures BPV ctd CF ctd 7

8 Bloomberg defines risk as 100x BPV BPV CTD = , multiply x32 = /32s x $31.25/32 nd =$59.74/$100k face value BPV CTD USM6 = x 32= /32s = $138.16, CF M6 = BPV Estimator: (Mod.Duration x Dirty Price) BPV per million face 9.7 x = /$mm, or $138.16/$100K face value In anticipation of a Yield Curve shape change, a trader would seek a hedge ratio that reconciles price volatility at the long end with price volatility at the short end of yield curve. For example: BPV NOB HR = ctd bond /CF ctd bond BPV ctd note /CF ctd note Eurodollar/Bond HR= BPV ctd bond /CF ctd bond $25 EuroDollar/Bond ratio: Examples HR = $138.16/ = $ $25 $25 = :1 or roughly 5 Eurodollars/1 bond Better still, 32 Euros per 7 bonds 32x$25 = $800 $ = ($138.16/1.2083)x7 Notes/Bonds: BPV CTD /CF CTD-M6 x HR HR = $138.16/ $59.74/ = :1 or 5 notes/3 bonds BPV note $59.74/ x 5 = $ BPV bond $138.16/ x 3 = $ BPV spread = +/- $6.27 8

9 S&P 500 futures ES aka emini S&P 500 ESH6 ESM6 Jan 4=today March 17 June DTM 163 DTM P x x The cost of carry determines the slope of the term structure curve. F H6 = S exp [ (r-d) t ] = exp[ ( ) (72/360) ] = ESH6 is trading 0.65 cheap to FV (fair value), SPH6 is 0.70 cheap to FV. F M6 = exp [ ( ) (164/360)] = x March 06 June 06 time ESM6 is trading 0.97 cheap to FV SPM6 is trading 0.22 cheap to FV Foreign Exchange Futures prices in the F/X market r 1 = d = U.S. short term rate - the interest rate you forego the opportunity on. Foreign short term rate- the rate at which you invest the foreign exchange. The interest rate differential (between the two sovereign rates) determines the carry. When r > d [Negative Carry] - the dollar price of foreign exchange is at higher and higher levels in deferred months. {Premium currency} Premium currency Carry in FX Discount currency F = S exp[ (r-d) t] 1 r and d are reversed if you want a European direct quote; i.e. A variable amount of fx for a fixed amount of US$ When r < d [Positive Carry] - the dollar price of foreign exchange is at lower and lower levels in deferred months. {Discount currency} 9

10 Actual differentials US $ EUR $ EUR 1 mo. LIBOR 4.40% 2.391% 4.75% 2.00% 3 mo. LIBOR 4.541% 2.49% 4.95% 2.125% 6 mo. LIBOR 4.68% 2.639% 5.25% 2.25% Actual Forwards Interest rate carry Actual Swap Points Spot $ $ mo.forward $ $ mo.forward $ $ mo.forward $ $ Simulated differentials Simulated Forwards Simulated Swap Points How will the rate differentials change going forward? 48 ticks $ R $ >> R $ R $ > R 66 ticks $ Mar. 06 Jun. 06 time R $ > R Thank You Kevin Baldwin Director, Education kbaldwin@theifm.org Institute for Financial Markets 2001 Pennsylvania Ave. NW Suite 600 Washington DC Tel: Fax: info@theifm.org 10