March 26. Steepening bets in eurodollars continue
–Interest rate futures continued to rebound Friday as tens fell another 3 bps to 2.24%. Stocks were weak early but came back to close higher. There was a ‘glitch’ associated with the Bats exchange where a sale of 100 shares of AAPL transacted just above $542, when the stock had been around 598. At a price of $542, $50 billion would have vanished from the market cap. The trade was cancelled at that price, and the low was adjusted to 594.40. Markets are much different now, but in the old days of the CME trading floor, whenever a market hit an “air pocket” of no bids or offers, that high or low was nearly always revisited within a couple of weeks. In a case like this where the price gapped lower, the action said to me that longs were already in and therefore didn’t have resting bids below the market, and shorts were in strong hands that weren’t anxious to cover on the first minor dip. Bats story: http://www.businessweek.com/articles/2012-03-23/bats-all-folks-the-epic-fail-of-the-worst-ipo-ever Even in the electronic era, the “flash crash” low of May 6 2010 was taken out (after a large bounce higher), by the end of that month.
–There was another large euro$ option trade expressing a view which has already been entered several different ways recently in size: Sold 0EM 9937p/ bought 3EM 9837/9812ps paying 3.0/3.5 for 50k. Synthetic steepener. There are 1 million open positions just in blue June puts compared to less the 700k in all four futures contracts comprising the blue pack. This at a time when several Fed officials, notably Bullard, are expressing concern about inflation. (see further notes below)
–On the other hand, Italy’s Monti warned about Spain’s finances, which could cause a contagion flare-up and send money into safe havens (USD).
–From ZeroHedge: “Sturm, Ruger (the 4th largest gun-maker in the US) who after receiving orders for over one million units in Q1 has temporarily suspended the acceptance of new orders.” So there are SOME bright spots in the economy…
–Treasury auctions 2’s, 5’s and 7’s this week.
NOTES / LARGE BLUE EURODOLLAR OPTIONS: There are over 1 million open positions in blue June puts. In blue June calls 726k open. In the blue pack futures (EDM15, U15, Z15 H16) there are only 696k open.
–On Friday a new position was entered selling 50k 0EM 9937p and buying 50k 9837/9812ps for 3.0 to 3.5. These options expire 15-June, 2012, in 82 days. Blues have been in focus, 3 years forward, as that’s the part of the curve just beyond the Fed’s vow to keep rates low. There are other scenarios that could also cause near term steepening, for example a loss in sponsorship for the long end of the treasury curve either by the Fed itself, or by other domestic and foreign participants, concerned about a combination of inflation and budget worries. A quote in Business Insider by David Kotok sums it up: “We do not know how this process will end. We have never been in a place where the major central banks of the world have tripled the sizes of their balance sheets and have driven the short-term interest rate near zero. We are in uncharted waters. We do not know where the rocks and shoals lie.”
Read more: http://www.businessinsider.com/kotok-uncharted-waters-2012-3#ixzz1q22mK48Q
Another quote from ZeroHedge underlines a possible inflation catalyst: “US non-financial corporates hoarding of a $630bn mountain of money in 2.5 years (or 85% of retained earnings) have retarded the most incendiary effects of the Fed’s extraordinary actions. The key issues will be whether these same corporates will begin to spend this cash…”
In any event, what the large trade mentioned above did was to crush vol in the red midcurves, sending 0EM 9937^ down from 17 to 15 and 0EU 9925^ from 27.5 to 26. The roll from EDH13 (99.41) to EDM14 (99.345) is 6.5. So all other things being equal, EDM3 will roll up 6.5 bps in the next 82 days and the 0EM puts will be worthless. But EDH15 (98.395) to EDM15 (98.20) has a roll of 19.5, so even the blue put spread would go out worthless. This trade and all the others like it are dependent on curve steepening. At recent lows EDM13 traded 9924.5 while EDM15 traded 9798. If we expired at those levels the back put spread would fill out to 25, against a loss of 13 on the 0EM puts, a net gain of 12, less 3.5 paid. The risk, which seems rather small, is that something occurs to cause a bear market flattener, where EDM13 leads a sell off. The other consideration to bear in mind is whether the size of these option positions can create unexpected futures moves.
