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An Insight To A Rare Side of Trading |
My name is Raj Kapadia, I have been trading for over 6 years, mainly in the fixed income field. After initially trading US stocks outright and not being able to find consistency or make any type of living from it, I enrolled in a prop trading course specializing in spread trading, where the primary focus is on wealth building rather than hitting those home runs.
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“Rule number one of investing is never lose money. Rule number two is never forget rule number 1″
Spread Trading basics
Well I said it in the last post that the way it was looking we would get a good non farm, but not in the way I would have thought. Rather then a good amount of jobs added we had a dramatic reduction in the unemployment rate from 8.1% to 7.8%. It is very timely actually but it lead to some volatility initially before it all faded before the close of the US session.
Theres no disguising that there is still a lot of problems, and with the run in to the US elections I wouldn’t be surprised to see more and more good data, to give the President a boost, before the Americans go to the polls.
So going forward I would expect to see some pressure on the Bund, unless we have any major announcements out of the EU.
Spreads are very slow and static at the moment so best to wait for good levels and hold until it comes your way.
Other then that not much else to report.
A strong ISM manufacturing and ISM Non-Manufacturing coupled with a slightly stronger ADP reading bodes well for a potential upside surprise in this Fridays non farm payroll number. Although there has been discrepancies in the past between ADP and NON farm, I got a feeling we are going to get a good number this Friday, which coincides with the run in to the presidential elections…hmm conspiracy theorist say what you will!
Thus we have maintained these near high levels in the equity markets as Europe isn’t creating many new headlines, so in that aspect there is no real reason to go down, and when ever we do we simply seem to be brushing it off.
Although I do feel we will come off cause the market doesn’t represent the current state of the economy, near term I think we will continue higher.
STIRS have been fairly static lately, with low volatility meaning having to hold on to spreads for much long then usual. As the Bund keeps on rising, spreads have been gradually coming off, and as they’re coming near the bottom of the range, (on many 3 months spreads) I’ve been inclined to buy them. Sep13Dec13s at 4.5 is a level which has held strong before so have been trying to load up on this as it comes.
Tomorrow we have ECB press conference, but this is likely to be a non event as the main actions were taken last month, but any surprise announcement will be welcome.
After a huge run up in stock markets, on all corners of the globe, it seems now that Europe questions are being asked again, the optimism is waning The Dow dropped 100 points yesterday despite good data out of the US regarding consumer confidence.
The Bund is always consolidated above 140, having been trading mid 138s last week.
The real question is has anything changed, we have assurances from central banks that they will fully support indebted nations, but the fact remains that we are still not growing, numbers look weak and without growth its hard to grow out of this mess, and for this reason longer term I dont see no other way to go then sell stocks, and buy Bunds. Stocks have been artificially bid on the back of the Fed Easing strategy, but there’s no real macro fundamentals to really back this up.
Earnings next week will paint a better picture next week, but although we are likely to get better numbers, its more by being efficient, cutting costs rather then employing workers and growing rapidly.
Looking at STIR spreads they have been in a tight range as you would expect, and so just playing the small moves nicking half tick here and there seems best play. Nothing really notable to mention in the past week, but we have been seeing more volume in these STIRs which is good, with over 100k contracts trading on many contracts.
Been looking at Brent Oil Spreads, and that saw a breakout on Monday in the 1 month butterflies at the front of the curve, which was a bit nasty, although it has faded some of it. These spreads are moving quite a bit, so providing more opportunity but much more breakout prone lately.
As far as the rest of the week goes, not much on the calendar, and we look to next week as we get a raft of data to see where we go.
The German Constitutional Court has ratified the eurozone bailout package. The bill will now be signed into law.
At issue was the legal matter of whether the permanent bailout fund which the eurozone nations had established (the European Stability Mechanism) was in keeping with the German constitution.
The ESM is a scheme which allows joint funds to be spent buying debt directly from governments. These governments would request help after finding it too expensive to borrow from the market. Unlike the OMT, its potential size is limited to €700bn. Germany will take on 27.15pc of these contributions, giving it a maximum liability of €190bn. Of this sum, €80bn (or €21.72bn for Germany) must be paid up front to the ECB.
We had quite a wild move on the back of this as the Bund initially went bid before selling of hard to reach a low of 139.24. The Euro also breached 129, as optimism has grown greatly. Couple this with likely QE out of the FED tomorrow, has led to dollar weakness and a big drop in the dollar index.
Spread wise we have steepened as you would expect with the big fall in the Bund, but the shorter end of the curve has stayed pretty stagnant with only a slight upward move in the Euribors.
Below is some video analysis on the past weeks moves.
So we got the expected volatility last week as the ECB delivered on the promise that the market was expecting, and this in turn lead to Euro strength, as we traded above 1.28. As far as Bonds are concerned, we had a big sell of and traded 139 handle, on the new Dec12 Bund contract, its been a long while since we have had sub 140 prints in the Bund, and is a definite sign of more risk appetite.
We dropped as low as 139.42 in the Bund, on the back of the proposed Bond purchases from the ECB, but we pushed up over 100 ticks on Friday as US Non farm payroll disappointed, and was a timely reminder that the Global Markets are still sluggish and there’s still along time till things will really turn around.
Have bounced twice from 139s, I expect mid 139s to be a buy as I cant see us falling too much more in this Bund.
Points of interest in the Bund to the Upside is 140.94-141, 141.38 and 142.48 to the down side, 139.42, 140.63.
Its a similar way Spreads pushed up on the back of Draghi actions, but faded this move on the disappointing non farm payrolls. I was trading the Mar14Jun14 quite a bit and was selling it up the way up from 7.5s to 8.5s, and this worked out as it came back down to 7-7.5s.
It was a similar story along the curve.
Looking forward, we have gone back to the sideways low volatility markets but looking for further progression out of Europe as well as FOMC press conference and projections on Thursday.
So after the euphoria of the comments from ECB officials which sent spreads higher, we have now got a full retrace from that move as we are trading 4.5/5s in sep13dec13 after trading as high as 7.5, this is the case along the curve as we have flattened by 20 ticks + from earlier levels between sep13 and dec14. The fade was always the trade, but it was all about timing and with such a big move up at the time it was hard to know where it was going to stop.
Looking at things as they are, I’m favouring long here in the Euribor spreads as we are in this big range, and here I think we have good value. Secondly we have pushed up 300 ticks in the Bund since last week trading now at 143.90 after being as high as 144.37, but at the same time we have had a rally in the Euro as well as other currencies as we have had alot of dollar weakness.
Now with the Bunds heading towards highs (currently at 143.90) and dollar retreating, something has to give, and a long dollar short Bund trade could be a good hedge, as we enter September and the big players may be returning and see this disconnect.
143.60 was the level we spoke about in the last analysis on the break of 142.20, this has now turned to support after the break above it. The Bund has pushed higher since then so a break of this support could see us trade back down below 143, with the next targets as 142.55 and 142.20.
Alot of the movement will hinge on what Draghi will be saying at the ECB press conference next week as the market is eagerly anticipation some type of decisive action, so there could be a lot of positioning before then as speculation will continue till the meeting.
So hopefully September will provide more volatility and volume then we have had recently!
A quick look at the moves over the past few weeks, as the unwinding of some cramped trades has lead to Bunds falling over 500 prices from its high and a big steepening in the Bond Yield curve as one would expect with such a down move.
In what was one of the most crowded trades in the market, the drop in the Bund lead to a domino effect as we came off over 250 points in over a day as we traded below 141 this morning, before seeing some retrace currently trading at 141.70.
This big move in the Bund was accompanied by a big stock move, or a big move in the Euro which suggests its Bond specific, as traders may be betting on a big announcement from European officials when they get back from there summer break.
This move down in the Bund, prompted a big drop in Euribors also and hence some major steepening along the curve. Spreads moved more then I have seen in a long time, with barely any retrace making it a very difficult and tough day to trade, especially for mean reversion traders like myself. What made it harder was that there was no real apparent news for this big move, so no real warning either.
Mar14Jun14 was trading 7.5/8s before trading as high as 10s this morning. This action has been the same along the curve, with bigger moves on wider maturity spreads.
I’ve been selling these all the way up, and I’m holding put as personally I think this is overdone, but Im slowly taking bits of the table to lower risk, but this by far has been the most trend day so far of the year I can remember. But I guess its better then flat lining.
Although the move up yesterday was on low volume as expected in August, so hoping for some type of retracement.
Not much else out for the week, so will be taking it easy, watching where these Euribor Spreads settle.
An introduction into the basics of Calendar Spreads, and with some real time example with the Eurodollar Future.
