“the nature of the trade means offsetting profits from the fall in bond prices means the trade is probably overall profitable…. the convexity of the trade - it acts like a cheap option on bond yields.” - do you mind elaborating on this ? Much appreciated
Sure. Due to rise in yield and particular curve configurations, the cheapest to deliver bond is more likely to change than has been the case for some years, especially for the Long Bond, which has 54 deliverable bonds in its basket. If you are long the cash bond and short the future you own the option to deliver whatever bond you wish, not just the bond that is currently the cheapest to deliver. Overall, this means your long a cash bond that will outperform the future if there is a rise, or indeed a fall, in yields, or a change in shape of the yield curve. You can also emulate this via options, but the options prices are more expensive, which reveals futures prices are overall expensive relative to the probability of changes in CTD.
My wonder is why there is a consistent arbitrage between futures and spot Treasuries, you would imagine that with so much pressure from HF it will go down. Any idea?
I suspect that as yields continue to rise at the back of the curve, this will gain a great deal more attention by the punditry, whether or not it is the driver. they are always looking for a culprit
That is a good question. Partly, I think it is unfamiliarity with distortions caused by higher rates (such as convexity in deliverables). The extreme basis we're seeing is a relatively novel - for years low rates meant there was almost zero optionality, so attention to basis declined. Also, my experience suggests large asset managers often value liquidity higher than you would expect. Why? Maybe because process efficiency is (has been) valued more highly than arbitrage opportunity.
Hi Andy, basis trade has already acquired a degree of attention that relative value traders never imagined was possible. What it shows is how money-market funds success in attracting investors is directly linked to current ONRRP returns, and which also acts as a backstop reservoir of liquidity to fund risk trades. As usual, there is information in the risk trade, which requires leveraged investors effectively to are buy volatility which others have made artificially cheap because they don't want it. It is a way of highlighting building risk in Treasuries which has been underplayed (till last month).
“the nature of the trade means offsetting profits from the fall in bond prices means the trade is probably overall profitable…. the convexity of the trade - it acts like a cheap option on bond yields.” - do you mind elaborating on this ? Much appreciated
Sure. Due to rise in yield and particular curve configurations, the cheapest to deliver bond is more likely to change than has been the case for some years, especially for the Long Bond, which has 54 deliverable bonds in its basket. If you are long the cash bond and short the future you own the option to deliver whatever bond you wish, not just the bond that is currently the cheapest to deliver. Overall, this means your long a cash bond that will outperform the future if there is a rise, or indeed a fall, in yields, or a change in shape of the yield curve. You can also emulate this via options, but the options prices are more expensive, which reveals futures prices are overall expensive relative to the probability of changes in CTD.
My wonder is why there is a consistent arbitrage between futures and spot Treasuries, you would imagine that with so much pressure from HF it will go down. Any idea?
I suspect that as yields continue to rise at the back of the curve, this will gain a great deal more attention by the punditry, whether or not it is the driver. they are always looking for a culprit
That is a good question. Partly, I think it is unfamiliarity with distortions caused by higher rates (such as convexity in deliverables). The extreme basis we're seeing is a relatively novel - for years low rates meant there was almost zero optionality, so attention to basis declined. Also, my experience suggests large asset managers often value liquidity higher than you would expect. Why? Maybe because process efficiency is (has been) valued more highly than arbitrage opportunity.
Hi Andy, basis trade has already acquired a degree of attention that relative value traders never imagined was possible. What it shows is how money-market funds success in attracting investors is directly linked to current ONRRP returns, and which also acts as a backstop reservoir of liquidity to fund risk trades. As usual, there is information in the risk trade, which requires leveraged investors effectively to are buy volatility which others have made artificially cheap because they don't want it. It is a way of highlighting building risk in Treasuries which has been underplayed (till last month).