The Short End

Published on: June 21st, 2017

Contrary to everyone else, Raoul thinks the market is soon going to start pricing in rate cuts in the US and he has a great risk/reward way of playing this…


  • AG
    Abhimanyu G.
    9 November 2017 @ 14:16
    Dear Raoul, A couple of questions on my mind: - What is the current cost of a Long December 2018 98.75/99.25 call spread? - Are you adding to this position? - Why do you prefer to hedge your equity position using the above structure, versus a put spread on an equity index? Your thoughts are always appreciated and respected! Regards, Abhimanyu Many thanks!
  • ca
    courage a.
    3 September 2017 @ 10:30
    Hi How do you play this trade with a CFD account based in the UK ?
  • JL
    J L.
    31 July 2017 @ 11:31
    Curious how much commission you guys and girls being charged for the options, I was quoted 175$ for 10k$ worth of 98.75 calls (100*2500*4c) on interactive
    • NL
      Nicholas L.
      31 July 2017 @ 18:04
      EF: Just previewed your quote on IB. For 100 units on the 2 legs the quote is $350. Not cheap.
    • GM
      Gerald M.
      3 August 2017 @ 15:25
      Thanks for proving the quotes. Getting $10K exposure for $175 is >57x leverage which is about the same as Forex. Seems reasonable.
    • GM
      Gerald M.
      5 August 2017 @ 03:50
  • rm
    robert m.
    3 August 2017 @ 20:51
    Raoul, can you provide a couple other approaches that will achieve your end result using ETFs or other securities. My understanding of currency trading is limited at best. Thanks.
  • NL
    Nicholas L.
    31 July 2017 @ 18:12
    Raoul: Great first piece. Thank you! I have two questions if you don't mind. Firstly, do we need to be concerned about Libor being phased out for the recommended trade. See Secondly, could you provide some advice on how you yourself position into a trade like this. We have a Dec 2018 expiration. Let's say I wanted to invest $2000 into this. Do you recommend 50% now, then wait ~6 months to see if the trade is heading in the right direction (economy weakening, FED backpedalling, Libor rates falling, etc) and commit the other 50%? Just trying to figure out your approach to the trades you will be recommending. Thanks!
  • NB
    Neil B.
    30 July 2017 @ 02:34
    RAOUL: BTW, just wanted to add, Questions posed below in my prior for you just in case you are skimming thru the tops of comments and don't notice the embedded questions. Thank you!
  • MN
    Mark N.
    19 July 2017 @ 01:34
    First, very appreciative of the insights already gained through subscribing to Macro Insiders. Next, let me plead ignorance here. I have traded equities and options for quite some time on a personal basis. After subscribing to RVTV a few years ago, I have been working to educate myself on the various investment vehicles and now do some forex and futures. All of this is possible with my current broker. However, in this case of Eurodollar Options, my broker is unable to put this trade on let alone provide price/volume info. Can anyone offer suggestions on what brokerages I can use to get better info on options pricing and possibly put this trade on for me (or do myself)?
    • JL
      J L.
      21 July 2017 @ 18:10
      I can see the options available in the UK on both Interactive Brokers and Saxo, however Saxo introduced a financing fee on options with 120+ days expiry last month (I think 1 or 1.5%)
    • GS
      George S.
      24 July 2017 @ 21:54
      Can you please give me the tickers for IB? Personally I can't find them.
    • LK
      Leigh K.
      24 July 2017 @ 22:19
      Try GE
    • GM
      Gerald M.
      29 July 2017 @ 15:13
      Don't use TD Ameritrade. They trade the Eurodollar futures but not the options on those futures. They do trade options on US Notes which might be used to structure a similar trade.
  • NB
    Neil B.
    29 July 2017 @ 14:30
    Nice innaugural piece Raoul. Thank You. I was also confused by the "steepening of the yield curve segment" in this piece. I would have thought the yield curve will actually flattened into a recession due to Long Rates falling ( i.e. risk off and $ into Longer Term bonds ). With the help of some of the comments ( specially the one RYAN C. made to PAT B. and RAOUL 's comments ) and re-reading/studying that segment of the piece several times it made more sense to me. I think I got what RAOUL was conveying now. But let me re-state below (1) and (2) just to be sure and see if anyone wishes to confirm back my accuracy in comprehension: (1) The yield curve initially steepens heading into and during a recession due to "recessionary expectations" which causes BOTH Short Rates and Long Rates to fall together ( i.e. "risk off" drives $ out of risk assets and into both Short and Long Term Bonds thereby pushing rates down respectively due to "risk off" $ accepting less and less of an interest rate to park $ into "safer" assets ), but Short Rates will fall faster than Long Rates ( due to "expectations" of Short Rate cuts by the FED ) thereby steepening the yield curve ( even though both Short and Long Rates are declining ). (2) Furthermore, during such a cycle, both previously issued Short Term and Long Term bonds will rise in price due to the current Interest Rate declining for newly issued Bonds ( i.e. fresh "risk off" $ flows coming out of risk assets and into "safer" assets willing to accept lower and lower interest rates on newly issued Bonds ). -- Does this all make sense the way I have stated it? Have I got it right? Please comment back and set me straight if not thanks! -- ** Also a specific question for RAOUL please **: Might you also start to include alternative ways to express trades ( even though perhaps not optimal in your book ) alongside your optimal for those who may not have the ability or expertise to engage in the more complex vehicles like Options, Futures and Forex? ( realizing in this case you were only referencing an Options trade but in the future you may also tap into Futures and Forex which not everyone may be able to engage in ). For example, in the proposed trade for this piece, might an acceptable approach be to "simply" allocate/scale $ into either the the IEF ( US 7 to 10 Yr. Government Bond ETF) or the TLT ( US 20 Yr. Government Bond ) ETF in anticipation of the "risk off" trade coming to fruition? They appear on the charts to be at technically good rising channel trend support buy zones as the TLT ( CBOE 10 Yr. treasury note Yield ) appears to be at a possible topping out zone within declining channel on the charts. Of course, the reward part of the risk/reward equation on such an ETF based approach would not be anywhere near as attractive in terms of total % gain upside compared to your options spread trade if the thesis pans out. But would it at least also create an attractive risk/reward expression of the idea? Not sure if there would be other expressions as well, but these are the ones which come to mind. Thanks!
  • MG
    Miguel G.
    27 July 2017 @ 10:06
    Hi Raoul I def agree with your thesis of rates eventually heading lower. I think 2017 could be range bound for rates but with comparables getting tougher after Q1 2018 its going to be hard for the US to continue its rate of change acceleration in growth. One thing I would like to point out is the spec money being massively long the US 2 year bond (longer than they were in 2007). At that time it was just before the financial crisis and rates had bottomed from there. Does this spec money possibly see some real issues that may arise later this yr maybe across the pond? I love your idea here but I expressed it differently buying gold and silver and a couple miners at gold 1209 oz. What are your thoughts on metals here if we are to see much lower rates shouldnt we see a bull run in metals? Going back to my 2007 set up where spec money was massively long 2 year bonds (even bigger in size today) gold went up 30% within 6 months. I think the set up here rhymes with what were seeing today which I make an argument we could see 1600-1700 gold by next year. What are your thoughts?
    • MG
      Miguel G.
      27 July 2017 @ 10:08
      FYI meant rates had topped in 2007, not bottomed.
  • JQ
    JACK Q.
    12 July 2017 @ 12:01
    Stupid question, the yield curve part - shouldn't it be the otherway around? 2s rise faster than 10s, so your 2s10s curve flatten rather than steepn?
    • FM
      Fraser M.
      13 July 2017 @ 15:15
      Jack - just noticed the same thing. Curve flattening suggests recession not steepening...
    • ZA
      Zameer A.
      17 July 2017 @ 09:56
      Why do this trade today as opposed to when the fed is closer to ending the cycle (unless of course you believe that is the case now). Also, you don't get paid much for the 99.25 calls. Rather not sell that and buy 98.75 call outright.
    • SC
      Sean C.
      17 July 2017 @ 14:29
      You could buy the calls and wait for /GE to rise and THEN sell the calls to get more premium. That way you have a better hedge. That makes sense.
    • PB
      Patrick B.
      23 July 2017 @ 01:25
      I am confused by the yield curve segment. If 2y rates rise faster than 10y rates in a recession, and the spread is the difference between the two, then wouldn't the spread tighten rather than steepen?
    • JR
      Jeff R.
      27 July 2017 @ 05:33
      Patrick, I believe his point is the opposite . In a recession, rates would fall on both the two year and the 10 year, from the cumulative effect of fed rate cutting, investors fleeing to the safe haven of bonds, and falling demand for loans. Then again I could be completely wrong 😂
  • rc
    ryan c.
    26 July 2017 @ 21:28
    Just my two cents on some comments below... Pat B - The way I understand it is as follows: The yield curve inverts (or flattens/is flattened in Raoul's logical thesis) prior to the recession (indicating a recession is near). Once Fed realizes we are actually in a recession, they cut rates / add stimulus and the curve steepens (ST rates fall faster than LT rates). Zameer - The reason, I think, Raoul suggests putting this trade on right now has a lot to do with the favorable risk/reward, currently. The trade is a cheap way (currently) to express a recessionary/rate cutting thesis in the next 18mos (this is currently ~non-consensus). As the trade stands now, it has exponentially higher payout if correct but only a fractional sized, relatively immaterial loss if wrong. If you wait til the market begins to price in recessionary expectations where everyone believes a recession could come tomorrow and that the Fed will start cutting asap, then the trade (option premiums) becomes much much more expensive. Sean C - in a perfect world, that would be awesome. The way I see the rational for Raoul's spread trade is because it makes the trade materially cheaper that way (currently 25% cheaper from the .04 Long and .01 Short premium prices i see). IMO, he might not believe that Fed cuts / 3mo LIBOR can fall materially below 75bps in next 18mos (though he probably sees LIBOR falling sub 75bps post Dec18). IMO, the spread he suggests is simply just a way to lock in a cheaper expression of the Long ST Rates trade. IMO - Although I have no idea what LT UST option premiums are currently going for, one potentially interesting way to execute this strategy slightly differently is to short LT rate call options and buy the aforementioned Eurodollar call options. That way, if wrong, and if LT rates actually do continue to go up, they would only go up about as much as ST rates so you wouldn’t lose as much money. But if Raoul is right in his thesis , most of the rate decline would be in ST rates (so the Long Eurodallar call profit would/should exceed the loss on the Short LT Rate call). Just my 2c as I try to think through this whole thing. Certainly not trying to put words into Raoul's mouth, just my interpretation of his thesis. Raoul/others, feel free to correct me where I am wrong (actually please correct me where I'm wrong). Great stuff - enjoyed reading/learning!
  • JH
    John H.
    17 July 2017 @ 20:21
    Nice. Agree taking in 0.5c (bid-side premium) for the EDZ8C 99.25 doesn't seem worthwhile, but agree long EDZ8C 98.75 is interesting. Re the 10Y and 2s10s discussion, one thing doesn't add up for me: in laying out up/down, Raoul says 0% is where 10Y could go. But if that were the case (and short rates were bounded by 0%), then curve would flatten going into this recession, unlike in previous recessions where Raoul correctly points out 2s10s steepened. I think this maybe has confused some readers who posted comments.
    • RP
      Raoul P. | Founder
      17 July 2017 @ 23:55
      Sorry if I wasnt clear... lets say that growth begins to weaken and 2 yr rates go to 0% and 10 years go to 1.5% then it steepens. Even if 2 years go to -1%, the chances are that 10 years is at 0.5% or less, so the curve stays steeper than here. The steepness is lessened vs normal because of absolutely lowness of rates overall. Hence why Japan has not seen a 300bps positive yield curve or anything like it in several decades.
    • JQ
      JACK Q.
      19 July 2017 @ 13:08
      Gotcha - thanks Raoul, that clarified it

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He retired from managing client money at the age of 36 in 2004 and now lives in the tiny Caribbean island of Little Cayman in the Cayman Islands. Previously he co-managed the GLG Global Macro Fund in London for GLG Partners, one of the largest hedge fund groups in the world. Raoul moved to GLG from Goldman Sachs where he co-managed the hedge fund sales business in Equities and Equity Derivatives in Europe. In this role, Raoul established strong relationships with many of the world’s pre-eminent hedge funds, learning from their styles and experiences.

Other stop-off points on the way were NatWest Markets and HSBC, although he began his career by training traders in technical analysis.

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