MARKET MOVER - BNP PARIBAS - Investment Services India

More documents

Recommendations

Info

are more or less hitting a brick wall, 5s10s will dictate what happens with 2s5s10s, i.e. a flatter 5s10s will likely widen 2s5s10s. Applying a similar thought process, we expect the back end of the curve to flatten as rates settle down. Treasury 10s30s is trading at 118bp, some 6bp shy of the all-time high of 124bp in August. In swaps, the corresponding figures are 79bp (current) vs 89bp, respectively. Table 1 shows the carry of these positions. The 2s5s10s fly and 10s30s flatteners carry negatively but not excessively so. For example, the Treasury 10s30s has a 2bp cost of carry over three months. On the other hand, 5s10s has positive carry for Treasuries and negligible carry for swaps. So, just wait until rates settle down and then act? Easier said than done, we know. What should we take as the signal that the rally is running out of steam and a new range is being established? Unfortunately, there is no magic formula here. To circumvent that rather inconvenient challenge, we make these trades contingent on rates remaining low for some time (i.e. stability). More specifically, we recommend conditional bull-flatteners using receivers struck OTM, indeed below spot levels. This ensures that we get into the flatteners if rates drop further and stay there for some time. To state the obvious, the conditional trade does not protect against a steepening scenario at low rates. 5s10s is trading at 103bp spot, and 99bp 3m forward as of this writing, indicating that the carry/rolldown effect is 4bp against a flattener. Furthermore, ATMF gamma vol on 10y tails is more expensive than 5y tails, and receiver skew on 10s is higher, which means that there is an additional cost to be paid for doing the trade in conditional form. As an example, let’s suppose we choose the 5y and 10y strikes 30bp below the forwards for a 3m bull-flattener. The breakeven in this case is about 4bp below the forwards, i.e. the curve has to flatten by 4bp relative to the current forwards (8bp in total, relative to spot) to recoup the premium paid upfront. This translates to a 5s10s spread of around 95bp. For reference, at the end of August, 5s10s traded in the 91-95bp area for a brief period once 5s stuck around their lows. In other words, the conditional flattener lends itself to the scenario we are depicting in which rates drop and stay low, establishing a new range and prompting duration extension trades. Bulent Baygun 23 September 2010 Market Mover, Non-Objective Research Section 20 www.GlobalMarkets.bnpparibas.com
US: A Carry Trade with Extra Potential • After the FOMC statement, the question arises once again about a Japan-like scenario. • We explore a carry trade with a few added kickers in case the swap and vol curves start to evolve the way they did during the beginning of Japan’s experience. • STRATEGY: Buy 4y1y vs selling 2y1y receivers, both 50bp OTM and equal notionals. Holding period is up to one year. As the front end continues to richen, the carry on offer keeps getting compressed. What should one do, since the latest FOMC statement reinforces the idea that this strategy can still be profitable? One approach would be to analyse various different long positions and hunt down the best carry or alpha. Another approach we explore here is to find a rolldown strategy that has a few added kickers in case the vol surface and swap curve start to evolve the way they did during the beginning of Japan’s experience. Rather than simply buying receivers, the trade is to buy 4y1y vs selling 2y1y receivers (both 50bp OTM, same notionals). This way, one can capitalise on the spread between these two forward rates and also the vol ratio, if we stay mired in the low rate environment for a while. As we show later, this is where we see the asymmetric risk that helps the trade when considering the beginning of Japan's experience. Table 1 shows the exact trade details and greeks. The current entry cost is 27.5c and after one year the position gains 40% (see Chart 1 for PnL profile). The rolldown is partly due to positive theta, but mainly due to the 2y1y leg having a steeper vol rolldown than the 4y1y. Chart 2 shows that the 2y1y/4y1y vol ratio of around 90% drops sharply to 70% after one year. In Japan, the ratio is 50%. Since the 4y1y rate is currently 10-20% more volatile than 2y1y, this makes the position trade like a long on the market since the 4y1y receiver leg will move more. Another feature which makes the trade directional is that the vol ratio tends to fall in a rally – helping the position – while rising in a selloff (see Chart 3 for relationship). 250% 200% 150% 100% 50% 0% Chart 1: PnL Profile Under Rate Shifts 1y Holding Instantaneous -50% -75 -50 -25 0 25 50 75 Change in 5y Rate (with beta-implied curve movement) Source: BNP Paribas Chart 2: Sharp Rolldown in Vol Ratio over 1y 140% 130% 120% 110% 100% 90% 80% 70% 2y1y over 4y1y USD Vol Ratio 1y1y over 3y1y USD Vol Ratio 60% Jan-06 Dec-06 Nov-07 Oct-08 Oct-09 Sep-10 Source: BNP Paribas Chart 3: Vol Ratio has been Directional to Rates 110% 105% 100% 95% 90% 85% Jan-10 Feb-10 Apr-10 May-10 Jul-10 Sep-10 Source: BNP Paribas 2y1y over 4y1y USD Vol Ratio 4y1y USD Rate (right scale) 5.0 4.5 4.0 3.5 3.0 2.5 2.0 Suvrat Prakash 23 September 2010 Market Mover, Non-Objective Research Section 21 www.GlobalMarkets.bnpparibas.com
Page 1 and 2: Euromoney Interest Rates Survey 201
Page 3 and 4: ECB on a different page… …but i
Page 5 and 6: developments and is prepared to pro
Page 7 and 8: and property tax payments, dropped
Page 9 and 10: directly to effect outright purchas
Page 11 and 12: Services also on the slide The ‘f
Page 13 and 14: inflation rate is calculated exclud
Page 15 and 16: closer to a more normal level” to
Page 17 and 18: point advance in the June Tankan. P
Page 19: US: Belly of the Curve is Rich, but
Page 23 and 24: MBS: Remain Underweight, GNM CBRs U
Page 25 and 26: EUR: Re-Enter Flatteners on 5y/10y
Page 27 and 28: EGBs: Market Update & Top Trade Ide
Page 29 and 30: EUR Covered Bonds: Market Update
Page 31 and 32: GBP Curve Opportunities Update •
Page 33 and 34: Table 1: BNP Paribas' Inflation For
Page 35 and 36: Table 3: BNP Paribas' Inflation For
Page 37 and 38: Table 1: BNP Paribas Carry Analysis
Page 39 and 40: have been happy to buy the roll to
Page 41 and 42: Technical Analysis - Interest Rates
Page 43 and 44: Trade Reviews Options, Money Market
Page 45 and 46: ond market attracted huge swathes o
Page 47 and 48: warning to Greek banks that it migh
Page 49 and 50: Chart 2: EUR/SEK - major support be
Page 51 and 52: Economic Calendar: 24 Sep - 1 Oct G
Page 53 and 54: Economic Calendar: 24 Sep - 1 Oct (
Page 55 and 56: Key Data Preview Chart 3: US ISM Po
Page 57 and 58: Key Data Preview Chart 7: US Consum
Page 59 and 60: Key Data Preview Chart 11: Japanese
Page 61 and 62: Key Data Preview Chart 7: UK CIPS M
Page 63 and 64: Economic Calendar: 4 - 29 October 4
Page 65 and 66: Next week's T-Bills Supply Date Cou
Page 67 and 68: Economic Forecasts GDP Year 2010 (%
Page 69 and 70: Market Coverage Market Economics Pa

MARKET MOVER - BNP PARIBAS - Investment Services India

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?