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Guy LeBas @lebas_janney
, 14 tweets, 6 min read Read on Twitter
Time for a pre-turkey #tweetstorm on the biggest positioning/flows driver in the US #interestrates and #bond markets, and it’s a monster. 1/
As always, some background. This story starts in the #Eurodollar futures markets, which are basically bets on where 3m LIBOR will settle on a given day. E.g., a Dec 2019 ED contract pays based on where 3m LIBOR is on Dec 16, 2019. 2/
When expectations of 3m LIBOR fall, ED prices rise and vice versa. So the price of an ED is like a bond in that respect. 3/
ED markets are huge and liquid, at least out through 3-4yrs. Beyond that, Treasury futures are probably more liquid. But the key to this story is the EDs have lots of (relatively) options that trade. 4/
In 1Q-3Q 2018, some monster players accumulated massive ratioed put spreads (I’ll explain shortly) in the ED markets. You can see long form explanation here (@macrotourist) and here (@zerohedge). 5/
Short version is that some monster trader put on massive positions in ED options markets totaling an estimated 3mm puts net short position. That’s something like $800 billion in notional value and it also compressed rates volatility. 6/
Attention on these monster trades has faded, but they’re still HUGE value drivers in the rates complex. Time to explain a ratioed put spread. All you delta one people should buckle up before reading; options experts skip this part. 7/
A put is basically a bet that the price of something—in this case a Eurodollar future—is going to fall. Pretty straightforward. If you buy a put, you pay for it, and your PnL looks something like this (as the price goes to the left of the graph, profit rises): 8/
A put spread (PS) is a combination of long put and short put positions. A 1x1 PS is a bet that something is going to fall in price, but you’ve basically capped your profit. In exchange, your cost for buying the put is less and your PnL looks something like this: 9/
A ratioed put spread is a combination of a long put and a multiple of short puts. A 1x2 PS means you’re long 1 put and short 2. It’s usually much cheaper, but your PnL now looks like this: 10/
The key here is that, with ratioed PS, you make money up until a point, then you start losing it. The bigger the ratio (1x2, 1x3, 1x4, etc), the steeper the losses become. In a 1x4 PS, you most likely get PAID premium in exchange for taking massive tail risk: 11/
Back to our ED monster. 12/
In summary, the biggest value driver in the US interest rate markets is a massive long position—long, in the sense that it wins as long as rates don’t rise much. Why have we collectively forgotten about it? Not sure, but it’s THE flows driver in the rates markets still! 14/
I’ll finish with a piece of advice: don’t fight a rates monster by being too bearish on US rates. You might win up until a point, but you’ll eventually get flattened. Embrace the monster. The End/
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