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Trading The TED Spread Malcolm Baker Senior Director, Regional Head of FX & IR APAC CME Group
Trading The TED Spread Malcolm Baker Senior Director, Regional Head of FX & IR APAC CME Group
Malcolm Baker Senior Director, Regional Head of FX & IR APAC CME Group
Outline
What Makes TEDs Move • Volatility in the Large • Volatility in the Small
Resources
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Trading the TED Spread: What’s the draw?
Anyone can trade it, large or small. It accommodates different trading styles.
There’s something in it for nearly any time horizon – seconds, minutes, days, or
weeks. There’s something in it for both aggressor price takers and resting price
makers.
It rewards creativity.
Especially in construction and management of the Eurodollar leg, if spread
structure is empirical (“Empricial TEDs”).
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Trading the TED Spread
TED = Treasury-Eurodollar spread
Bank credit spread Unsecured interbank (ie, London interbank offered) interest rate
exposure
minus
US Treasury note yield exposure
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What Makes TEDs Move
Volatility in the Large Volatility in the Small
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Volatility in the Large
At low frequencies, pro-cyclical measure of commercial bank credit-spread exposure.
Leading indicator of real economic cyclicality. TED widens in late stages of
business cycle expansions, and narrows in business cycle downturns. Where business
cycle downturn is preceded by financial upheaval, TED’s cyclical peak tends to
coincide with the upheaval (eg, US equity market crash of 1987, US equity market
“tech wreck” of 2000, US banking crisis of 2008).
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Volatility in the Large
As Libor-reference interest rate swap market has matured, TED volatility has
trended lower. In terms of median of absolute daily changes in TED spread: 1988-
2000 – 2.7 bps for 5-yr 2.5 bps for 2-yr 2001-present – 1.7 bps for 5-yr 1.4 bps
for 2-yr
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Volatility in the Large
Open issues for the future
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Volatility in the Small: Example -- Front ZF v 1st Green GE
At higher frequencies, TED spread dynamics are heavily influenced -and often
dominated -by market expectations of US monetary policy.
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Volatility in the Small: Example -- Front ZF v 1st Green GE
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Volatility in the Small: Example -- Front ZF v 1st Green GE
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Structuring the Trade
Preliminaries Analytical TEDs Empirical TEDs
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Preliminaries: Futures v Futures TEDs
Buy Long TED = Short TED = Treasury Eurodollar Sell Eurodollar Treasury
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Preliminaries: GE Leg PV01 = Treasury Leg PV01
Example: On 23 Aug 2013, how many GE to spread versus ZTF3 or ZTU3?
ZFU3 Treasury Futures PV01 Number of GE Futures = Treasury Futures PV01/$25 $48.97
per contract $24,485 per 500-lot 979 GE per 500 ZFU3
ZTU3 $37.82 per contract $37,820 per 1,000-lot 1,513 GE per 1,000 ZTU3
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Preliminaries: GE Leg -- Analytical or Empirical?
Analytical TEDs Popular in the 1990s, especially among strategic users. * Use term
structure of GE futures rates to construct term structure of Libor-basis discount
factors. * Use Libor-basis discount factors to value Treasury security cash flows
as if it were a Eurobond. * For each GE futures contract, perturb that segment of
term structure of Libor-basis discount factors to find PV01. * Result: GE
combination that mimics synthetic Eurobond with cash flows identical to Treasury
security. Pro: Synthetic Eurobond structure can be expressed in terms of notional
yield comparable to Treasury yield. Con: GE combination is rigid. Requires great
care and effort to enter and exit.
Empirical TEDs Pioneered by government securities dealers and interest rate swap
dealers for tactical use. TED = Forward 3-month Libor associated with an
arbitrarily chosen GE contract of combination of GE contracts (stack, pack, bundle)
minus Forward-starting Treasury note yield.
Pro: Agnostic, tractable, easy to trade. Con: Lacks yield that is directly
comparable to Treasury yield.
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Preliminaries: GE Leg -- Analytical or Empirical?
Example: On 23 Aug 2013, which GE, and how many, to spread v 1,000 ZTU3?
Delivery Month
Empirical Stack
Empirical Pack
Empirical Bundle
} }
Whites
184 219 218 217 838 676 1,513 378 378 378 378 1,512 216 215 213 31 1,513
Reds
1,513
1,513
Source: Our thanks to Bill Campbell for suggesting inclusion of the “Lemon” TED.
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Analytical TEDs
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Analytical TEDs: Example -- 23 Aug 2013 Trading Session
Construct synthetic Eurobond exposure that matches the TED’s Treasury exposure. On
22 Aug 2013…
Use GE contract rates and Libor (for settlement on 26 Aug 2013) to get term
structure of Libor-basis discount factors. Each rate becomes a segment in term
structure of Libor-basis discount factors. For Libor or GE contract rate, ri-1, for
interval from settlement date ti-1 to maturity date ti , discount factor segment di
= 1 / [ 1 + ((ti - ti-1)/360) * (ri-1 / 100) ] For date tc, cumulative discount
factor (for t0 = 1) is Dc = Πi=0…c di
GE Prices
GE Rates (Pct)
IMM Wednesdays
3-Wk Libor U13 Z13 H14 M14 U14 Z14 H15 M15
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Analytical TEDs: Example -- 23 Aug 2013 Trading Session
On 22 Aug 2013…
Assume: Cheapest-to-deliver Treasury note into ZTU3 = 1-7/8 of 30 June 2015
Expected ZTU3 delivery date = 3 October 2013 (ie, last day of ZTU3 delivery month)
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Analytical TEDs: Example -- 23 Aug 2013 Trading Session
On 22 Aug 2013…
ZTU3 Daily Settlement Price = 109-312 (= 109 and 31.25/32nds) ZTU3 delivery
conversion factor for CTD issue (1-7/8 of 30 June 2015) = 0.9324 Expected clean
invoice price for delivery on 3 Oct 2013 = 102 and 17.82/32nds (= 109 and
31.25/32nds x 0.9324) Apply Libor-basis discount factors to CTD Treasury note cash
flows to get synthetic Eurobond price.
Dc CTD Treasury Note Discount Cash Flow Factors Dates (3 Oct 2013 = 1) fc Cash
Flows Dc x fc Synthetic Eurobond Present Values (as of 3 Oct 2013) ZTU3 Invoice
Price for Delivery of 1-7/8 of Jun 2015 on 3 Oct 2013 Term TED Spread (Bps)
14.4
Synthetic Forward Eurobond Yield for 3 Oct 2013 Forward Treasury Yield for 3 Oct
2013 Forward TED Spread for 3 Oct 2013
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Analytical TEDs: Example -- 23 Aug 2013 Trading Session
On 22 Aug 2013…
* One by one, perturb each GE contract rate (fourth column) by 1 basis point. *
Resultant change to term structure of discount factors (third column) changes
synthetic Eurobond present price. * Differential from synthetic Eurobond’s
unperturbed price is PV01 of that GE contract. * Divide PV01 by $25 to determine
how many of that GE contract to incorporate in synthetic Eurobond. Synthetic
Eurobond shown below assumes Treasury leg is 1,000 ZTU3 (where each ZT contract is
for delivery of $200,000 face value of contract-grade Treasury notes).
GE Delivery Month Synthetic Eurobond Discount Factors (Number of GE Contracts) (3
Oct 2013 = 1) GE Rates (Pct)
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Empirical TEDs
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Empirical TEDs: Correlation Surface for ZF
Establish how various GE contracts or contract structures correlate with Treasury
exposure. Then pick spots on the correlation surface that suit your purposes.
Correlations of daily price changes – Front ZF v GE
In the long run: 28 Aug 2003-2013 …and lately: 30 May – 28 Aug 2013
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Empirical TEDs: Correlation Surface for ZT
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Empirical TEDs: Correlation Surface High Points
Let “long term” = 28 Aug 2003-2013. Let “short term” = 30 May – 28 Aug 2013.
Stacks
Bundles
5-Year 5-Year
94.2 98.8
Front ZT Long Term Short Term 1st Red 2nd Red 88.7 93.1 Red Red 89.1 93.2 2-Year 2-
Year 88.4 94.3
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Empirical TEDs: Robustness Check
Inspect relationship between Treasury and Eurodollar legs in both long term and
short term.
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Managing the Trade
Implementing Interest Rate Spreads Bid-Offer Spreads Examples Initial Margin
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Managing the Trade: What’s the Right Framework?
Price Spreads
Not recommended. Easy to compute, messy to interpret: GE leg is a forward interest
rate. Treasury leg is a forward asset price.
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Implementing Interest Rate Spreads
TED Spread = GE contract interest rate minus Forward-starting yield on CTD Treasury
note as implied by Treasury futures delivery invoice price
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Implementing Interest Rate Spreads: Example
Calculating carry: Prices and rates on 22 Aug 2013 for regular (t+1) settlement on
23 Aug 2013 ZFU3
CTD Treasury Notes for U3 futures Accrued coupon interest, 23 Aug – 3 Oct 2013 (per
100)
Clean price, 22 Aug 2013 for regular (t+1) settlement on 23 Aug 2013 (points and
32nds)
Accrued coupon interest from last coupon date to 23 Aug 2013 (per 100) All-in
price, 22 Aug 2013 for regular (t+1) settlement on 23 Aug 2013 Treasury GC term
repo, 23 Aug – 3 Oct 2013 (pct/yr) Financing cost, 23 Aug – 3 Oct 2013 (per 100)
Carry (per 100) = Accrued coupon interest minus financing cost
Source: IHS Global Insight, CME Group, CME Group calculations
96-19½ = 96.6093750
0.143442623
(84 days/183 days) x (5/8) / 2
102-24¼ = 102.7578125
0.275135870
(54 days/184 days) x (1-7/8) / 2
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Implementing Interest Rate Spreads: Example
Treasury Leg Setup for 23 August 2013 ZFU3
CTD Treasury Notes for U3 futures Price on 22 Aug, for regular (t+1) settlement on
23 Aug (points-32nds) Carry from 23 Aug to 3 Oct futures delivery (points-32nds)
Forward price = Price minus Carry (points-32nds) Forward yield for forward
settlement on 3 Oct 2013 Conversion factor for Sep 2013 futures delivery Futures-
equivalent forward price (points-32nds) = Forward price / Futures delivery
conversion factor Futures daily settlement price, 22 Aug (Points-32nds) Futures-
equivalent net basis, 22 Aug = Basis excluding carry (32nds)
Source: IHS Global Insight, CME Group, CME Group calculations
2 / 32nds
96-17½
6.4 / 32nds
102-17.85 0.400 pct 0.9324 109-31¾ 109-31¾ 0
1.484 pct
0.8044 120-0¾ 120-0½ ¼
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Bid-Offer Spreads
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Bid-Offer Spreads
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Example: 500 ZFU3 v 979 GEU5 on 23 Aug 2013
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Example: 1,000 ZTU3 v 1,513 GEU4 on 23 Aug 2013
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Initial Margins and Margin Offsets
500 ZFU3 v 979 GEU5
ZF Initial Margin = $990 1st Green GE Initial Margin = $600 Position Initial Margin
w/out Margin Offsets 70% Margin Offset: (1 x ZF) v (2 x 1st Green GE) Position =
490 MO Units + 10 1st Green GE Initial Margin with Margin Offsets $327,930 = (490 x
$657) + (10 x $600) $495,000 = 500 x $990 $587,400 = 979 x $600 $1,082,400 $657 =
0.30 x ( 1 x $990 + 2 x $600 )
Source: Examples are hypothetical, and are based on CME Clearing performance bond
and cross-margin settings as of 25 September 2013.
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Resources
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Resources
Bloomberg LP Cheapest-to-Deliver Function -- (BBG Futures Contract Code) <COMDTY>
DLV <GO> Burghardt, Galen The Eurodollar Futures and Options Handbook, McGraw-Hill,
2003 Burghardt, Galen, et al The Treasury Bond Basis, 3rd Edition, McGraw-Hill,
2005 CME Clearing Margins --
http://www.cmegroup.com/clearing/margins/#e=all&a=all&p=all CME Group Eurodollar
Futures: The Basics http://www.cmegroup.com/trading/interest-
rates/files/eurodollar-futures-the-basics.pdf CME Group Globex Trade Match
Algorithms
http://www.cmegroup.com/confluence/display/EPICSANDBOX/GCC+Product+Reference+Sheet
http://www.cmegroup.com/confluence/display/EPICSANDBOX/Matching+Algorithms CQG
Integrated Client http://www.cqg.com/Products/CQG-Integrated-Client.aspx
http://www.cqg.com/Electronic-Trading/Features/Spread-Trading-in-CQG.aspx Trading
Technologies Autospreader® https://www.tradingtechnologies.com/en/products/trading-
analytics/xtrader/autospreader/ US Department of the Treasury 31 CFR Part 356, Sale
and Issue of Marketable Book-Entry Treasury Bills, Notes, and Bonds, Appendix B
http://www.law.cornell.edu/cfr/text/31/356
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Done, with gratitude
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Disclaimer
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 f utures 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 references to options refer to options on futures. Swaps
trading is not suitable for all investors, involves the risk of loss and should
only be undertaken by investors who are ECPs within the meaning of section 1(a)12
of the Commodity Exchange Act. Swaps 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 swaps 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. Any research views expressed are those of
the individual author and do not necessarily represent the views of the CME Group
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presentation has been compiled by CME Group for general purposes only. CME Group
assumes no responsibility for any errors or omissions. Additionally, all examples
in this presentation 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 Exchange rules. Current rules should
be consulted in all cases concerning contract specifications. Copyright © 2013 CME
Group. All rights reserved.
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