Fed Funds vs Eurodollars futures

The interest rate markets offer a lot of possibilities and strategies. You can trade the outright, the intra-product spread (calendar spread or calendar spreads combinations) and you can create your own spread with different futures (inter-product spread) Sometimes I analyze the outrights and certain spreads but today I’m going to introduce a strategy used by some of the biggest market participants. 

      CME Interest Rate Products, source CME

The spread

I’m not going to focus on the back of the curve. The products to make this strategy are Eurodollar futures and Fed Fund futures. Before I explain the strategy lets define these products:

• Eurodollar futures are based on a 3 month LIBOR.
• Fed Funds futures are based on the average daily effective Fed Funds rate and calculated the last business day

Considering the different  value per basis point we need to calculate the spread ratio:

Spread ratio, own elaboration                                                  

In order to get the ratio, we should divide the Eurodollar value per basis point by the Fed Fund value per basis point. In our case, we will trade 10 Eurodollar contracts and 6 Fed Funds contracts. Considering the forward-looking aspect of Eurodollar futures, the Sep contract will cover from September to December. We need to choose 2 different Fed Fund contracts between these maturities, in the example October and November.

Spread calculation in basis points, own elaboration                 

In the example, the spread in basis points has been calculated as (Fed Funds average price – Eurodollar price) *100

    Eurodollar-Fed Funds spread, source TradingView

What and why are we trading on this spread? Basically, we are betting that the spread between these 2 products will narrow or wide in the future. Having in mind that the eurodollar is based in 3-month commercial loans will be more volatile (for the duration and the credit risk) than the Fed Funds (1-month loan between banks insideUnited States)

We can use this spread to bet that the interest rate curve will change. Let’s say that if there was a high probability of an interest rate hike, I would position myself short Eurodollars and long Fed Funds.

          Fed Funds Rate, source TradingEconomics

If you compare this chart with the previous one, you can see why you need to be right and always taking the direction of the market with the Eurodollar contracts.

Sum up

I hope you like this brief introduction. This spread will allow you to diversify the strategies. There are 2 main risks: taking the wrong side of the position and the execution risk. The second one is obvious because there are 2 different products on this strategy.  It´s easier to make a calendar spread because you can find them listed on the exchange. 

Have a good trading!!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

Eurodollar futures, examples and strategies to trade the interest rate curve

Introduction 

As you know, the Eurodollar futures represent the 3 months interest rate futures. I like the interest rate derivatives because they don’t usually have big movements like indexes, currencies or commodities. Another advantage is that there are a lot of contracts listed on the exchange and you can apply different strategies. The liquidity is very high, unfortunately, it’s not a fast market and getting filled is not easy due to the exchange algo.

We will talk about trading but understanding macroeconomics helps a lot in this kind of products. Let me show you why:

Current Macro view

The U.S. is showing its strength every time they release its macroeconomic indicators. Last week we showed a better than expected GDP growth (3.0%). October has been really good: strong durable good orders (2.2%), better than expected ISM manufacturing PMI, strong services PMI, an increase in Existing Home Sales, 4.2% as an unemployment rate. On the other hand, the Non-Farm Payrolls were worse than the market forecasted due to the effect of the hurricanes. The consumer price index wasn’t as good as the Federal Reserve would like it. But in general terms, the macro data was very good.

Considering all of these facts and a hawkish FED that expects three rate hikes in 2018, the Eurodollar futures should be falling at the moment.

Quick look at the Outrights

 Eurodollar December 2017

     Source: TradingView, Eurodollar Dec17, daily

This is the December 17 contract. It was lower at the beginning of the year because everyone expected a hawkish FED. The USD was really strong at this time. The FED delivered the first rate hike in March and obviously, the interest rate futures fell. After that, this contract rose to set up the maximums of the year in June. This movement was driven by the doubts about how a quick normalization and interest rate hikes could affect the economy. The main concern was the high level of personal debt and how the people could resist and pay in an environment where the interest rates were going up but the salaries were stagnant.  The Fed raised the interest rate in June for the second time of the year, and this contract fell until July. It seemed that everything was going well but the shadow of some geopolitical problems appeared. The front contracts rose. The Fed September meeting was a turning point and the confidence came back to the market. Janet Yellen announced that the Fed will start cutting its balance sheet in October, and she said that the normalization process would be gradual and predictable. At this moment, the sell side was the correct one.

 Eurodollar June 2018

     Source: TradingView, Eurodollar Jun18, daily

The June contract movement has been similar than the December 2017. The main difference is that the Jun18 is trading at the same levels of the beginning of the year, which in my opinion indicates that the market expects that the economy will continue growing in 2018.

 Calendar Spreads

If you think that trading outrights involves a lot of risks maybe you should consider calendar spreads and bet in the yield curve. Basically, you are betting that the difference between two contracts will wide or narrow. You can use technical analysis, macro analysis, quantitative analysis.

Eurodollar December 2017 - March 2018

    Source: TradingView, Eurodollar spread Dec17-Mar18, daily

Looking at the chart, you can see a clear trend that started in September. Does it sound familiar to you? The reason why this spread is going up is that the March 2018 contract has fallen more than the December contract. The economy is performing well, the market expects a rate hike in the beginning of 2018 and 2 more alongside the same year. At the moment, it’s trading at 0.1450, which I consider an important resistance.

Eurodollar March 2018 -  December 2018

      Source: TradingView, Eurodollar spread Mar18-Dec18, daily

This is a 9-month spread. You can see how well the spreads trend. It follows the same pattern as the other outright or strategies mentioned above. It was trending very well in September but it’s moving sideways and showing some weakness at the current levels.

Eurodollar September 2018 – June 2019

     Source: TradingView, Eurodollar Spread Sep18-Jun19, daily

This spread is different. The traders are pricing several interest rate hikes the yield curve is flattening. It has just crossed the 200 EMA and I think this movement will continue.

Eurodollar March  2019 – December 2019

     Source: TradingView, Eurodollar spread Mar19-Dec19, daily

This spread has been falling almost the whole year. The 200 EMA is very significant, every time that the spread closed above it the movement was reversed in a few days. As well as the previous one, it shows weakness.

Butterflies

If you agree that the spreads in 2018 are trending up while the spreads in 2019 are trending down and you would like to trade both, the best thing you can do it´s making a butterfly. This strategy consists of buying one spread and selling another one in which the middle leg is the second leg of the first spread. 

                       Butterfly structure, Step 1 and 2 are the spreads that create the butterfly, own elaboration

You can sell a butterfly if you do with 2 different spreads, you should sell the first one and buy the second one.

Let’s see these butterflies:

     Source: TradingView, Eurodollar Butterfly Mar18-Dec18-Jun19, daily

This is a very volatile butterfly but it’s a good example of this strategy. It supports the theory of buying the 2018 spread (Mar18-Dec18) and selling the 2019 spread (Dec18-Jun19)

     Source: TradingView, Eurodollar Butterfly Jun18-Dec18-Jun19, daily

This is less volatile than the first one. The best aspect is that it ranges all the time.It can rise to the levels drawn on the chart, but there is only my opinion.

Conclusion

I hope that you like. This is only a brief article but I hope that it will help you to understand how this kind of product behaves and the different strategies you can apply. Knowing about macroeconomics helps. I will be promoting this articles on the following twitter account: @fxfincomtrading

Thanks.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

#trading #eurodollar #macroeconomics #calendarspreads #butterflies #InterestRates #US #Fed

Why is the European Central Bank dovish? Interest Rate strategies

The European Central Bank is very conservative at the time of taking decisions on economic policy. And this fact has been confirmed again today. As expected, the ECB will cut asset purchases to 30 billion euros from 60 billion euros. This will start in January and it will last for nine months to September. One of the reasons why the ECB remained cautious is the weak inflation.

What did the EURUSD?

After the decision, the Euro plunged. 

     Source: TradingView, EURUSD Dec17 Future, 30 min

The market didn’t expect a hawkish decision and it was reflected in the movement of the euro. I started the day falling. You can see how the volumes got bigger around the interest rate decision and the ECB conference. Draghi was optimistic about the eurozone growth but he signaled that is concern about the inflation. Technically, the EURUSD futures has broken 2 important levels (1.1793 and 1.1729)

What is the real reason behind this decision? My opinion

Economics is a social science and predicting the individuals' behaviour is really difficult. Let me make an example to show my thoughts about this dovish decision.

Let’s imagine an ideal world in which the most important economies keep performing like the last couple of years, China’s GDP growth meets the 7%, the commodities keep rising, the Federal Reserve raises rates and makes substantial cuts to the asset purchases and there isn´t any economic shock. In this context, the US dollar will rise vs the euro. The conservative ECB policy will support a weak euro, and with the conditions mentioned, it will help Europe to keep growing and the inflation will peak.

On the other hand, applying the economic policy in Europe is difficult due to the differences between the strong economies and the peripheric economies. So whatever is applied needs to be good in general terms without affecting in a negative way to certain economies.

As a theory, it’s valid but it’s very difficult that all of these will happen.

What can we see in the Euribor futures?

Euribor futures are the interest rate futures in Europe. You will see in the following charts that an improvement of the European economy is not discounted.

Euribor Jun18 future

     Source: Barchart, Euribor Jun18

As you can see it fell at the beginning of this year, showing an improvement of the economy. At this time the inflation was growing and it hit 2% in March. The euro was weak in this period, the EURUSD was trading around 1.06. Since then, the Euribor jun18 has been rising due to the low inflation, the Brexit, the lack of change in the economic policy. Considering the uptrend, the market participants don´t expect changes in the economic policy neither a big improvement of the European economy.

Euribor spreads

Euribor March 18 – June 18

    Source: Barchart, Euribor Mar18-Jun18

Euribor March 18 – December  18

     Source: Barchart, Euribor Mar18-Dec18

These spreads show the same as the outright explained before. A falling spread means that the difference between the two futures is decreasing. Talking about the interest rate curve, we can see that the yield curve is flattening. The main difference between both spreads is the volatility. Obviously, the 9-month spread moves more than the 3-month spread. They are in lows of the year, I would consider buying if I expected an economic improvement. At the moment, I wouldn’t buy because I don’t  see any sign of reversal.

Another strategy to consider is a Euribor butterfly. 

     Source: Barchart, Euribor butterfly Jun18-Sep18-Dec18

The butterfly is in a support and it´s trading at the lows of the year. I think it´s a better choice than the spreads at the moment.

Euribor spread June 18 – June 19

     Source: Barchart, Euribor Jun18-Jun19

The main difference with the other spreads is that the overall trend is bullish. This means that the traders expect that the economy and the inflation will be better in 2019 than 2018. The main problem is that the triangle is one of the most dangerous figures in technical analysis and I wouldn´t trade it until it breaks. If you like interest rate futures you should add to your watchlist. There is a strong support at 0.1550.

Conclusion

First of all, I hope you enjoy this article. The interest rates market is my favourite. You should consider the macroeconomic indicators and follow the central bank meetings. It’s a fundamental market and less volatile than other markets. There are strategies such as spreads and butterflies that are listed at the exchanges so you won’t have execution problems in the different legs. Thanks.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

#Trading #ECB #Euribor #Euro #EURUSD #fundamentals #InterestRates #Macroeconomics #opinion #Spread #trading #TechnicalAnalysis  #butterfly #creatingValue

Why is good to try alternative trading strategies such as spreads?

When we think about trading, the first image we have is Wall Street, Canary Wharf, Frankfurt,  Chicago, Tokyo, Toronto, Singapur, Hong Kong, big investment banks, hedge funds, asset managements.

    Own elaboration

One of the biggest mistakes is thinking about getting rich quickly trading the financial markets. It doesn’t matter how many books you read or how qualified you are. Obviously, it helps but it's not enough. Also, you should consider that you can’t compete with the institutional investors and Banks as they can afford advanced technologies and they employ a lot of people.

The most important thing is risk management. Being focused and learning by doing is very important as well. Maybe you have a full time job and you would like to try to get an extra income from trading. If this is the case, you need to adapt your trading style to your situation. Maybe, instead of doing day trading, you need to look for a medium or long-term strategy.  If you are an individual trader or investor (not professional) I’d recommend the following steps:

1. Choose the market you want to trade with.
2. Making a trading plan and assessing the risk you are willing to take per trade (I wouldn´t risk more than 2% of the portfolio)
3. Adapt the strategies that suit with your current situation, and backtest them if possible (the best way is open a paper trading account) before using real money.
4.  Start trading and adjust the strategies if needed.

Trading is a long tough journey and carries a high risk even more if you use leveraged strategies. These 4 steps are a sum up about the whole process, I think I can make 20 steps or even more but it’s not the purpose of this post.

Spreads

    Source: TradingView, Eurodollar spread GEH18-GEZ18

This is a spread between two contracts of eurodollar interest rate futures. In this example, I’m using the Jun 18 and Dec 18 contract. As you can see it moves really well with less volatility than trading the outright. Let me make it clear with the following capture:

    Source: TradingView, Eurodollar spread GEH18-GEZ18 vs GEZ18

I´ve represented the Eurodollar Dec 18 futures in blue and purple while the spread between Jun18 and Dec18 is green and red. You can’t see the differences in the chart due to the scale but while the outright made a move of 40 ticks the spread move only 14.

The logic between the spread is different from the outright, you are trading the differences between 2 contracts.Basically, you are betting that the difference between both contracts will increase or decrease. 

The advantages of this strategy are:

1.  Less volatility
2. The margin required is less than the one if you trade an outright
3. You can do the spread between 2 different kind of futures (intra spreads, inter spreads)
4. You can take advantage of seassonality in commodities (I will write an article in the future)
5.  There are Exchange traded spreads, that you don’t need a specific funcionality in your trading platform

The disadvantages:

1. You need to know that you are trading the difference between two contracts so the logic is different
2. Higher execution cost
3. You need an autospreader or an specific functionality in your trading platform that is expensive

I hope you like it. I will write about different strategies in the future. Let me know if you are interested in an specific one. 

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverages involved