Thread by @discoverytrader

I was asked about why there are differences in #TEDSPREAD values/plotting, so here’s what you should know. The acronym “TED” is derived from #TREASURIES minus #EURODOLLARS & expresses the difference between theoretically risk free yield & yield with embedded credit risk (cont)…

…classically TED spreads are plotted using same term cash #TREASURY bills against #LIBOR yields. Most often the terms used are 1M & 3M month tenors, though overnight tenors can also be used. Of course any risk free rate can be used such as #SOFR, as in my previous post (cont)…

If you’re wanting to trade #TED spreads using futures and/or you don’t have access to an #EIKON or Bloomberg terminal for cash plots you can construct/trade a viable version of them synthetically using 2Y #TREASURY & #EURODOLLAR futures which is very common (cont)… $ZT $ED $GE

…to do so first you have to DV01 normalize the #EURODOLLAR leg to the 2Y #TREASURY leg. The current variable 2Y DV01 is about $34 bps & #EURODOLLAR is always fixed at $25 bps. So as close as you can practically get is 3x ZT against 4x $ED = $102 bps against $100 bps (cont)…

…so now you’ve got 3x $ZT - 4x $ED as your DV01 normalized #TED spread. Remember both these futures trade in price not yield so if you’re long $ZT you’re short yield and if you’re short $ED you’re long yield. So if you’re long the #TED you’re betting credit risk rises (cont)…

…but which #EURODOLLAR term to use? Remember your front leg is a fixed 2Y tenor but your back leg is not so practically you’ll want to pick a single $ED term as a ‘proxy’ for 2 years worth of curve rather than assuming cost of the whole strip -an 8 quarterly leg bundle (cont)…

…depending on where you are in the expiration cycle, either the 3rd, 4th or 5th $ED term will be the closest single term match. Where do you generally find the “average” yield out of an 8 term strip in a single maturity? Somewhere right in the middle obviously. (cont)…

…usually you’ll find the 1st #ED red term is a good start but you should also try the 4th white & 2nd red to be sure, again depending on where you are in the 2Y leg expiry cycle. How do you know when it’s as “right” as possible? Whichever plots the tightest range. (cont)…

…so for example currently the front 2Y leg is a DEC22 expiry & the first red $ED term is DEC23 but you can also plot SEP23 &/or MAR24 $ED terms to see what I mean. So that’s it. 3x DEC22 $ZT against 4x DEC23 $ED would be your initial prospective spread. Hope that helps. ✅

…afterthought. Someone asked about minimum tick increments. No, they won’t match. 3x $ZT at $7.81 1/4 ticks will be a $23 & change min increment & 4x $ED at $12.50 1/2 ticks a $50 min increment. Remember the $ZT leg will be about 2x as volatile & move about 2 for 1 on $ED leg

…I got another question about #TED spreading w/futures. Why the 2Y tenor? Quite simply because that’s the shortest term available for the risk free #TREASURY leg now. Way back in the 80s there was a 13WK bills contract at the Merc trading side by side w/#EURODOLLARS (cont)…

…but for whatever reason the $ED complex just took off and there wasn’t enough interest in the bills contract so it was nixed. So that’s why/how the 2Y became the most popular risk free leg for #TED spreaders from that point forward (cont)…

…but again as I said you can use any matched tenor to express your opinion about credit risk via #TED spreading risk free #TREASURY yield against #LIBOR yield. Can you use the 5Y or even 10Y futures against a single $ED term for the same purpose? Absolutely, & some do (cont)…

…when using 5Y or 10Y tenors as your RF leg it’s the same process for picking a single $ED term as your credit risk leg. Just pick a term roughly out of the middle of the 5Y or 10Y strip as a proxy for that amount of curve. +/- 2.5 years in for 5s or 5 years in for 10s (cont)…

…because someone is bound to ask, what if you wanted to #TED spread a tenor longer than 10Y? That presents a problem because #EURODOLLARS are only priced out 10 years. So to use say 30Y bond futures as your RF leg you’d need an $ED term you don’t have +/- 15 years out (cont)…

…obviously that wouldn’t be possible so your only option for TED spreading that far out would be to use a term matched #LIBOR swap against the RF #BOND future leg. But then that would be a swapped cash flow against a deliverable future which is impractical at best (cont)…

…but IF you were inclined to express credit risk opinions that far out the best way to do so would be to buy or sell an #OIS swap against a #LIBOR swap spreading cash flows. #OIS swaps are pegged to #EFFR so that’s your RF leg obviously & both are priced out as far as 50Y. Fin.

Oh, one last afterthought on futures #TED spreading. After JUN23 you’ll no longer be able in current form as that’s when the last of the cash #LIBOR rates will cease to be published & in turn when our beloved #EURODOLLAR contracts (at least w/current specs) are no more (cont)…

…after which remaining #EURODOLLAR contract open interest will settle to/be swapped for equivalent #SOFR contracts minus a fallback spread. Remember, those contracts are also pegged to RF rates like #TREASURIES. No credit risk spread in them so no #TED spreading w/them. 👎