Finding Opportunities in a New Interest Rate Environment

Transcription

1 INTEREST RATES Finding Opportunities in a New Interest Rate Environment The Interest Rate market is experiencing significant volatility in 2015, as market participants are anticipating when the FOMC will raise the Fed Funds target rate. CME Eurodollar Futures and Options, our short term interest rate products, are the preferred tool for professional traders who want to express a view on future interest rate moves. The word patient was removed from the FOMC meeting statement on March 18, introducing uncertainty into the timing of the first rate hike. FUNDAMENTALS OF CME EURODOLLARS The underlying instrument of the Eurodollar Future is a 90-day Eurodollar Time Deposit, based on $1 million face value Eurodollar futures are a cash-settled futures contract based on the 3-month LIBOR rate at expiration Quoted as 100-Yield: For example if the yield is 0.85%, the Eurodollar Future is quoted at (= ) The Basis Point Value of Eurodollar is calculated as the Face Value x (days/360) x 0.01% $1M x (90/360) x 0.01%= $25 1 tick is equal to a full basis point, which equals $25 (1 tick =.01 = $25). However, the minimum fluctuation for Eurodollar futures is one-half of one basis point (0.005= $12.50 per contract) for all contracts. It is worth noting that this tick increment is one-quarter of one basis point (0.0025= $6.25 per contract) when the front quarterly contract nears expiration. SNAPSHOT OF OPEN INTEREST (As of January 9, 2015 and 2014 ADV by Year) Year Color Open Interest 2014 ADV 1 White 4,257, ,486 2 Red 3,210, ,668 3 Green 1,887, ,774 4 Blue 916, ,297 5 Gold 352,705 85,293 6 Purple 63,722 9,223 7 Orange 29,862 1,743 8 Pink 7, Silver 3, Copper Serials 78,617 4,883 * Note: While there are non-quarterly months available, these are much less liquid than quarterly contracts How the world advances

2 FUTURE CONTRACTS DELIVERY MONTH CODES Contracts mature during the months of March, June, September, and December extending out 10 years in the future for a total of 40 quarterly contracts. 1 There is deep liquidity extending out more than five years. In futures contracts, the delivery month is reflected in the symbol name with a letter code, followed by the year. The Eurodollar symbol on Globex is GE (i.e. Eurodollar December 2015 futures=ge15). The letters for each month are listed below. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month Code F G H J K M N Q U V X Z EURODOLLAR FUTURES EXAMPLE (December 9, 2014 Snapshot) As highlighted in the table below, March 2016 futures had a high of and a low of , noting that each basis point move is worth $25. If you would have bought the March 2016 future low at and sold it at the high of , you would have made 8.5 basis points or $ Month Last Implied Yield Change Prior Settle Open High Low Volume DEC % ,247 JAN % ,011 FEB % MAR % ,779 APR % b MAY % b a 0 JUN % ,266 SEP % ,758 DEC % ,671 MAR % ,700 JUN % ,968 SEP % ,348 DEC % ,998 Note: Eurodollar contracts are quarterly, but there are also four serial contracts listed at any given time 1 There are also four nearest non-quarterly or serial expirations cmegroup.com/ir 2 Finding Opportunities In A New Interest Environment April 2015

3 MIRROR OF THE MARKET FORWARD RATES Pricing patterns in the Eurodollar futures market are very much a reflection or mirror of conditions prevailing in the money markets and moving outwards on the yield curve. The yield curve is a graph showing interest rate yields across different contract lengths (2 year, 5 year, 7 year, etc.) for a similar underlying debt contract. Eurodollar futures intra-market or calendar spreads reflect the shape of the yield curve, which is simply the yield of each bond along the maturity spectrum. A flattening yield curve means the gap between the yields on short-term bonds and long-term bonds decreases, making the curve appear less steep, whereas a steeping yield curve indicates the gap between the short-term and long-term bonds increases In order to hedge yourself against change in interest rates, as a general rule: Sell ED Futures > Hedge risk of rising rates Buy ED Futures > Hedge risk of declining rates TREASURY YIELD CURVE 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2 Yr 5 Yr 7 Yr 10 Yr 30 Yr 3/24/13 3/24/14 3/24/15 Yield curve expected to steepen Yield curve expected to flatten or invert Buy the curve, i.e., buy nearby and sell deferred futures Sell the curve, i.e., sell nearby and buy deferred futures Finding Opportunities In A New Interest Environment April

4 CALENDAR SPREAD TRADING A Calendar Spread is a spread trade involving the simultaneous purchase of futures or options expiring on a particular date, and the sale of the same instrument expiring at another date. CME Group offers listed calendar spreads on CME Globex with implied price functionality that expands trading opportunities, increases market liquidity and improves prices. This functionality allows resting bids and offers for outright Eurodollar futures to be automatically combined to create synthetic spread orders. The quoted values of the calendar spread traded as a spread can be tighter though than the outright market. By trading the Eurodollar calendar spread, you are trading the expectations for changes in the relationship between contracts in the same market with different expirations. Buying a Calendar Spread Buying a near-term contract month and selling a deferred month in Eurodollar futures (i.e. Buying the September 15/December 15 spread means you are buying September 2015 ED Futures and Selling December 2015 ED Futures) Selling a Calendar Spread Selling a near-term contract month and buying a deferred contract month (i.e. Selling September 2015 and buying December 2015 futures) Price of a Calendar Spread: Quoted as the price of the near-term or nearby contract less the price of the deferred contract. For example, the September 2015 December 2015 Eurodollar Calendar Spread is trading at a difference of 24 basis points. Contract Sep 15-Dec 15 Calendar Spread Bid Quantity Bid Price Ask Price Ask Quantity ED Future Sep ED Future Dec *Snapshot on March 6, 2015 at 1:50 pm If you think that spread is going to widen, you could buy the calendar spread. This can be accomplished by buying the outright contracts, paying on the September 2015 contract and selling in the December 2015 contracts. This would result in a price of 25 bps ( =0.25). Or you can trade this as a listed calendar spread where you can buy the offer at 24.5 basis points, saving you 0.5 basis points. Tremendous liquidity can be found in all of the resulting in the tightest bid-ask spreads. OPTIONS ON EURODOLLAR FUTURES Options on Eurodollar futures are among the most actively traded exchange-listed interest rate options contracts in the world. CME Group offers sixteen quarterly Eurodollar options corresponding to the quarterly Eurodollar futures with the underlying contract the corresponding quarterly Eurodollar futures. Eurodollar options are American Style, meaning they can be exercised at any time. If not exercised, the options will expire at 7:00 pm CT on the last trading day. The strike prices for Eurodollar options are listed in intervals of 12.5 basis points (0.125) in a range of 150 basis points above and below the strike that is closest to the previous day s underlying futures settle price. The Options are quoted in IMM index points. The tick size or minimum fluctuation is one-half of one basis point (0.005= $12.50 per contract) for all contracts. It is worth noting that this tick increment is one-quarter of one basis point (0.0025= $6.25 per contract) when the nearer contracts get closer to expiration. Eurodollar options provide the ability to limit losses while maintaining the possibility of profiting from favorable changes in the futures prices as they allow traders and hedgers an opportunity to take advantage of their views on the direction of the U.S. Interest rates. cmegroup.com/ir 4 Finding Opportunities In A New Interest Environment April 2015

5 OPTION LIQUIDITY One of the best ways to determine a contract s liquidity is by reviewing its Open Interest, the total number of contracts that are currently open (meaning the contracts have been traded but not yet liquidated by an offsetting trade, or for options, exercised or assigned). The higher the open interest, the greater the liquidity, which will make it easier to trade a particular option contract or strike within a contract. Across all of the Eurodollar options products, open interest is over 30 million contracts with a sufficient amount of open interest in the front quarterly contracts. EURODOLLAR OPTIONS OPEN INTEREST (As of March 15, 2015) 5,000,000 Contracts 4,000,000 3,000,000 2,000,000 1,000,000 0 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 The chart below focuses on the June 2015 contract, which has numerous strikes with Open Interest in the 100,000s. In the Summary Table, Total Open Interest in the Calls and Puts is 1 million and 2.6 million, respectively. EDM5 OPEN INTEREST Call Summary vs Total ITM OTM OI Change OI Change OI Change 1,114, , ,800-92, , ,846 Put Summary vs Total ITM OTM OI Change OI Change OI Change 2,625,045-46,080 3, ,621,545-46,280 Finding Opportunities In A New Interest Environment April

6 OPTION STRATEGIES TRADING EXAMPLE: Belief that Short Term Interest Rates (STIRS) will be higher before the contract s expiration. Purchase a Put: capturing a potential move lower in the futures Higher Interest Rate Lower Futures Prices Lower Interest Rate Higher Futures Prices EDM5 Prices: The below pricing sheet highlights that the June futures contract is trading at with an implied rate of 0.45% ( ). The at-the-money (ATM) strike price is therefore If you expect the STIR to be higher (futures lower), then purchase a PUT. Your strike price choice is dependent on your view of STIR + premium willing to pay. In this example, you choose the ATM Put (99.50 Strike). The intrinsic value (difference between the strike price (X) and the future (F)) of this Put is dependent on which way the futures move. If futures decline below the strike price of 99.50, then the Put will be in-the-money (ITM) If the futures price remains below the strike at expiration, then you will make money if the intrinsic value is greater than the premium you paid Put has a theoretical value of You paid 6.5 The premium you paid is.2, under the theoretical value You will make a profit if the futures price moves BELOW or more than 6.5 under the strike price of EDM5 PRICES BREAKEVEN CHART FOR ATM PUT (99.50 strike) cmegroup.com/ir 6 Finding Opportunities In A New Interest Environment April 2015

7 ADDITIONAL OPTION STRATEGIES: If the premium on the previous example is too high, you can offset part of that cost by selling one or two puts of lower strike prices against your original trade. Put Spread: Selling one put (of lower strike price) against previous Put Limits the potential gain to the difference between the two strikes (less the premium paid), but with the benefit of lowering your cash outlay Put 1x2: Selling two puts (same strike for the pair) against the ATM Put (strike 99.50) Decreases the premium paid even further compared to the Put Spread (may even create a net credit), but now there is some downside risk Note: How much risk depends on your view as well as how far away the strike you are selling is away from your purchase Benefit of a 1x2: If the market moves in your favor, especially over a period of time, you can purchase one of your short legs back then it simply becomes a Put Spread position PUT SPREAD PUT 1X2 Finding Opportunities In A New Interest Environment April

8 For more information about Implied Pricing Functionality visit: cmegroup.com/confluence/display/epicsandbox/implied+orders For market data, contracts and other information about CME Eurodollar Futures and Options visit: Futures: cmegroup.com/eurodollarfuturesquotes Options: cmegroup.com/eurodollaroptionsquotes For questions, contact: Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract s value is required to trade, it is possible to lose more than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade. All examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. CME Group is a registered trademark of Chicago Mercantile Exchange Inc. The Globe logo, Globex, CME and Chicago Mercantile Exchange are trademarks of Chicago Mercantile Exchange Inc. Chicago Board of Trade is a trademark of the Board of Trade of the City of Chicago, Inc. NYMEX is a trademark of the New York Mercantile Exchange, Inc. The information within this brochure has been compiled by CME Group for general purposes only and has not taken into account the specific situations of any recipients of this brochure. CME Group assumes no responsibility for any errors or omissions. Additionally, all examples in this brochure are hypothetical situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official CME, NYMEX and CBOT rules. Current CME/CBOT/NYMEX rules should be consulted in all cases before taking any action. The content of this marketing collateral should not be taken as a recommendation or endorsement to buy sell or retain any specific product, security investment or other service nor does it constitute a Prospectus. The content of this presentation is intended solely for the use of Eligible Counterparties and Professional (non-retail) Clients as defined under FSMA 2000 and circulation must be restricted accordingly. Potential users of the services herein described are recommended to take independent advice. This communication is issued by CME Marketing Europe Limited. CME Marketing Europe Limited (FRN: ) is authorised and regulated by the Financial Conduct Authority in the United Kingdom for the conduct of investment business. Copyright 2015 CME Group Inc. All rights reserved. PM1370/00/0515