us ted spread (1)

8/13/2019 Us Ted Spread (1)

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Trading the TED Spread

Malcolm Baker

Senior Director, Regional Head of FX & IR APAC

CME Group


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2013 CME Group. All rights reserved. 2013 CME Group. All rights reserved. 2

Outline

What Makes TEDs Move

Volatility in the Large Volatility in the Small

Structuring the Trade

Preliminaries Analytical TEDs

Empirical TEDs

Managing the Trade

Implementing Interest Rate Spreads Bid-Offer Spreads Examples Initial Margin

Resources


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Trading the TED Spread: Whats the draw?

Anyone can trade it, large or small.

It accommodates different trading styles.Theres something in it for nearly any time horizon seconds, minutes, days, or weeks.Theres something in it for both aggressor price takers and resting price makers.

It rewards attention to detail.In construction and management of the Treasury leg (Implementing the Interest Rate Spreads).In construction and management of the Eurodollar leg, if spread structure is analytical (Analytical TEDs).In handling differences in trade-match algorithms, if trading style is algorithmic.

It rewards creativity.Especially in construction and management of the Eurodollar leg, if spread structure is empirical (Empricial TEDs).

Its going to be around for a while.For as long as there is a market in US Treasury notes, and as long as theres a Libor.


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Trading the TED Spread

TED = Treasury-Eurodollar spread

Short-hand for Treasury-Swap spread

(where Swap means plain-vanilla ISDAFIX standard Libor-reference IRS)

Bank credit spread

Unsecured interbank (ie, London interbank offered)interest rate exposure

minus

US Treasury note yield exposure


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2013 CME Group. All rights reserved. 2013 CME Group. All rights reserved.

What Makes TEDs Move

5

Volatility in the LargeVolatility in the Small


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Volatility in the Large

At low frequencies,pro-cyclical measure ofcommercial bank

credit-spread exposure.

Leading indicator ofreal economic cyclicality.

TED widens in late stagesof business cycleexpansions, and narrows inbusiness cycle downturns.

Where business cycledownturn is preceded byfinancial upheaval, TEDs

cyclical peak tends tocoincide with the upheaval(eg, US equity marketcrash of 1987, US equitymarket tech wreck of

2000, US banking crisis of2008).

Source: IHS Global Insight


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As Libor-referenceinterest rate swapmarket has matured,

TED volatility hastrended lower.

In terms of median ofabsolute daily changesin TED spread:

1988-20002.7 bps for 5-yr

2.5 bps for 2-yr

2001-present1.7 bps for 5-yr1.4 bps for 2-yr

Source: IHS Global Insight, CME Group calculations


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Open issues for the future

What is Libor?

Pre-Wheatley Review, Libor is narrowly defined: Interest rates on unsecured interbank placement.Post-Wheatley Review, could the basis for establishing Libor be redefined?

Treasury-Eurodollar Spread v Swap Spread

TED quaTreasury-Eurodollar SpreadPure Treasury v Libor (whatever Libor turns out to be).

TED quaSwap SpreadValuation of Libor-reference interest rate swapsand quotes of Libor-reference swap rates -- may be

influenced by recent institutional changes in swap market regulation and practice (eg, increasingprevalence of central counterparty clearing of swaps, OIS as basis for valuation Libor-reference swaps,application of credit support annexes and various liquidity value adjustments (LVA) such as credit value(CVA) and debit value adjustments (DVA).

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Volatility in the Small: Example -- Front ZF v 1st Green GE

Source: CME Group

At higher frequencies,TED spread dynamicsare heavily influenced --

and often dominated --by market expectationsof US monetary policy.


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Source: CME Group


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Source: CME Group


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Structuring the Trade

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PreliminariesAnalytical TEDsEmpirical TEDs


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Futures-Futures TED is Forward-Starting Spread Exposure

Notional forward settlement date is expected delivery date for Treasury futures contract.

Treasury Leg

Front 2-Year Treasury Note (ZT) or front 5-Year Treasury Note (ZF).Avoid contracts in delivery: Use Treasury contract prior to its First Position Day(ie, 2ndbusiness day before 1stbusiness day of futures contract delivery month).

Eurodollar (GE) Leg

Whatever you want.

One Law : GE Leg PV01 = Treasu ry Leg PV01

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Preliminaries: Futures v Futures TEDs

Buy Sel l

Long TED = Treasury Eurodollar

Short TED = Eurodollar Treasury


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Example: On 23 Aug 2013, how many GE to spread versus ZTF3 or ZTU3?

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Preliminaries: GE Leg PV01 = Treasury Leg PV01

ZFU3 ZTU3

Treasury Futures PV01 $48.97 per contract$24,485 per 500-lot

$37.82 per contract$37,820 per 1,000-lot

Number of GE Futures =

Treasur y Futur es PV01/$25979 GE per 500 ZFU3 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 TEDsPioneered by government securities dealers and interest rate swap dealers for tactical use.

TED = Forward 3-month Libor associated with an arbitrarily chosen GE contract ofcombination 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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Example: On 23 Aug 2013, which GE, and how many, to spread v 1,000 ZTU3?

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Preliminaries: GE Leg -- Analytical or Empirical?

Delivery

Month

Analytical

Synthetic

Eurobond

Semi-Analytical

Lemon

TED

Empirical

Stack

Empirical

Pack

Empirical

Bundle

U13

} Whites

184 189

Z13 219 189

H14 218 189

M14 217 838 189

U14

} Reds216 676 1,513 378 189

Z14 215 378 189

H15 213 378 189

M15 31 378 189

Total 1,513 1,513 1,513 1,512 1,512

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

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, forinterval from settlement date ti-1to 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= i=0c di

GE

Prices

GE

Rates

(Pct)

Convexity

Bias

(Bps)

Adjusted Rates =

GE Rates minus

Convexity Bias

IMM

Wednesdays

Discount

Factors

(26 Aug 2013 = 1)

3-Wk Libor 0.172 0.172 18-Sep-13 0.999890

U13 99.730 0.27 0.270 18-Dec-13 0.999208Z13 99.680 0.32 0.1 0.319 19-Mar-14 0.998403H14 99.610 0.39 0.3 0.387 18-Jun-14 0.997427M14 99.525 0.47 0.5 0.470 17-Sep-14 0.996244

U14 99.410 0.59 0.8 0.582 17-Dec-14 0.994780Z14 99.270 0.73 1.1 0.719 18-Mar-15 0.992975H15 99.090 0.91 1.5 0.895 17-Jun-15 0.990734M15 98.860 1.14 1.9 1.121 16-Sep-15 0.987935

Construct synthetic Eurobond exposure that matches the TEDs Treasury exposure.


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On 22 Aug 2013

Assume: Cheapest-to-deliver Treasury note into ZTU3 = 1-7/8 of 30 June 2015Expected ZTU3 delivery date = 3 October 2013 (ie, last day of ZTU3 delivery month)

Use GE discount factors, for notional valuation on 26 Aug 2013, to interpolate discount factors for2-year Treasury note cash flow dates, for notional forward valuation on 3 October 2013.

IMM

Wednesday

Dates

Discount

Factors

(26 Aug 2013 = 1)

Discount

Factors

(3 Oct 2013 = 1)

Treasury

Cash Flow

Dates

Log-Interpolated Discount

Factors

(3 Oct 2013 = 1)

18-Sep-13 0.9995318-Dec-13 0.99860 0.9994304

31-Dec-13 0.999315319-Mar-14 0.99734 0.9986251

18-Jun-14 0.99541 0.997649230-Jun-14 0.9974930

17-Sep-14 0.99263 0.9964653

17-Dec-14 0.98860 0.9950015 31-Dec-14 0.994723618-Mar-15 0.98395 0.9931964

17-Jun-15 0.97843 0.990954530-Jun-15 0.9905540

16-Sep-15 0.97218 0.9881544


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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) = 0.9324Expected 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.

Synthetic Forward Eurobond Yield for 3 Oct 2013 0.544 pctForward Treasury Yield for 3 Oct 2013 0.400 pctForward TED Spread for 3 Oct 2013 0.544 minus 0.400 = 14.4 bps

CTD Treasury Note

Cash Flow

Dates

DcDiscount

Factors

(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)31-Dec-13 0.9993153 0.9375 0.93686

30-Jun-14 0.9974930 0.9375 0.93515

31-Dec-14 0.9947236 0.9375 0.93255

30-Jun-15 0.9905540 100.9375 99.98404

All-In Price 102.78860 103.04075

Clean Price 102.30457 102.55672

Yield 0.544 0.400 14.4


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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 Eurobonds 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

(Number of GE Contracts)

Discount Factors

(3 Oct 2013 = 1)

GE Rates

(Pct)

U13 184 0.9994304 0.270Z13 219 0.9986251 0.319H14 218 0.9976492 0.387M14 217 0.9964653 0.470U14 216 0.9950015 0.582

Z14 215 0.9931964 0.719H15 213 0.9909545 0.895M15 31 0.9881544 1.121

Total 1,513


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Empirical TEDs

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Empirical TEDs: Correlation Surface for ZF

Correlat ions of dai ly pr ice changesFront ZF v GE

In the long run: 28 Aug 2003-2013 and lately: 30 May28 Aug 2013

Establish how various GE contracts or contract structures correlate with Treasury exposure.Then pick spots on the correlation surface that suit your purposes.



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Empirical TEDs: Correlation Surface for ZT

Correlat ions of dai ly pr ice changesFront ZT v GE

In the long run: 28 Aug 2003-2013 and lately: 30 May28 Aug 2013



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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 Packs Bund les

Front ZF

Long Term 2ndGreen 93.4 Green 93.5 5-Year 94.2

Short Term 4thGreen 98.6 Green 98.4 5-Year 98.8

Front ZT

Long Term 1st

Red 88.7 Red 89.1 2-Year 88.4Short Term 2nd Red 93.1 Red 93.2 2-Year 94.3


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Empirical TEDs: Robustness Check

Movi ng 63-Day Correlat ion s of Daily Pric e Changes, 28 Aug 2003-2013


Inspect relationship between Treasury and Eurodollar legs in both long term and short term.


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Managing the Trade

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Implementing Interest Rate Spreads

Bid-Offer SpreadsExamplesInitial Margin


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Managing the Trade: Whats 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.

Interest Rate SpreadsReasonably easy to compute, especially for tactical trading purposes. Simple to interpret:

TED spread = GE contract interest rate (ie, forward-starting Libor)minus

Forward-starting yield on cheapest-to-deliver (CTD) Treasury note,as implied by Treasury futures delivery invoice price

DV01-weighted TED DV01 of in terest rate spread is immediately evident.

23 Aug 2013 Examples:For 500 ZFU3 v 979 GEU5, 1 bp change in spread = $24,485For 1,000 ZTU3 v 1,513 GEU4, 1 bp change in spread = $37,820


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Implementing Interest Rate Spreads

TED Spread = GE con tract interest rate

minusForward-starting y ie ld on CTD Treasury n ote

as impl ied by Treasury futures del ivery invoice price

Whats the GE contract interest rate?100 minus GE price

What determines the Treasury yield?Treasury futures invoice price for future delivery = (Futures price x CTD conversion factor) plus Basis Guesstimate

Basis Guesstimate = CTD basis (in futures numeraire) from previous nights close

Forward price of CTD issue = Spot (t+1) price minus Carry to forward settlement date(Carry = Accrued coupon interest minus repo financing cost)

Forward yield of CTD issue


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Implementing Interest Rate Spreads: ExampleCalculating carry: Prices and rates on 22 Aug 2013 for regular (t+1) settlement on 23 Aug 2013

ZFU3 ZTU3

CTD Treasury Notes for U3 futures 5/8 of 30 Nov 2017 1-7/8 of 30 Jun 2015

Accrued coupon interest,23 Aug3 Oct 2013 (per 100)

0.070013661(41 days/183 days) x (5/8) / 2

0.208899457(41 days/184 days) x (1-7/8) / 2

Clean price, 22 Aug 2013 for regular (t+1)settlement on 23 Aug 2013 (points and 32nds)

96-19= 96.6093750

102-24= 102.7578125

Accrued coupon interest from lastcoupon date to 23 Aug 2013 (per 100) 0.143442623(84 days/183 days) x (5/8) / 2 0.275135870(54 days/184 days) x (1-7/8) / 2

All-in price, 22 Aug 2013 for regular (t+1)settlement on 23 Aug 2013

96.752817623 103.032948370

Treasury GC term repo, 23 Aug3 Oct 2013 (pct/yr) 0.075 (7.5 bps) 0.075 (7.5 bps)

Financing cost,

23 Aug3 Oct 2013 (per 100)

0.008264303= 96.752817623 x

(41 days/360 days) x(0.075/100)

0.008800731= 103.032948370 x

(41 days/360 days) x(0.075/100)

Carry (per 100) =Accrued coupon interest minus financing cost

0.061749358= approx 2/32nds

0.200098726= approx 6.4/32nds

Source: IHS Global Insight, CME Group, CME Group calculations


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Implementing Interest Rate Spreads: ExampleTreasury Leg Setup for 23 August 2013

Source: IHS Global Insight, CME Group, CME Group calculations

ZFU3 ZTU3

CTD Treasury Notes for U3 futures 5/8 of 30 Nov 2017 1-7/8 of 30 Jun 2015

Price on 22 Aug, for regular (t+1)settlement on 23 Aug (points-32nds)

96-19 102-24

Carry from 23 Aug to 3 Oct futures delivery(points-32nds)

2 / 32nds 6.4 / 32nds

Forward price = Price minus Carry (points-32nds) 96-17 102-17.85

Forward yield for forward settlement on 3 Oct 2013 1.484 pct 0.400 pct

Conversion factor for Sep 2013 futures delivery 0.8044 0.9324

Futures-equivalent forward price (points-32nds)= Forward price / Futures delivery conversion factor

120-0 109-31

Futures daily settlement price, 22 Aug (Points-32

nds

) 120-0 109-31

Futures-equivalent net basis, 22 Aug= Basis excluding carry (32nds)

0


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Bid-Offer Spreads

Source: CME Group, CME Group calculations


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Bid-Offer Spreads

Source: CME Group, CME Group calculations


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Example: 500 ZFU3 v 979 GEU5 on 23 Aug 2013

Source: CME Group


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Example: 1,000 ZTU3 v 1,513 GEU4 on 23 Aug 2013

Source: CME Group


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Initial Margins and Margin Offsets

500 ZFU3 v 979 GEU5

1,000 ZTU3 v 1,513 GEU4

ZF Initial Margin = $990 $495,000 = 500 x $990

1stGreen GE Initial Margin = $600 $587,400 = 979 x $600

Position Initial Margin w/out Margin Offsets $1,082,400

70% Margin Offset: (1 x ZF) v (2 x 1stGreen GE) $657 = 0.30 x ( 1 x $990 + 2 x $600 )

Position = 490 MO Units + 10 1stGreen GE

Initial Margin with Margin Offsets $327,930 = (490 x $657) + (10 x $600)

ZT Initial Margin = $275 $275,000 = 1,000 x $275

1stRed GE Initial Margin = $451 $682,363 = 1,513 x $451

Position Initial Margin w/out Margin Offsets $957,363

50% Margin Offset: (2 x ZT) v (3 x 1stRed GE) $951.50 = 0.50 x ( 2 x $275 + 3 x $451 )

Position = 500 MO Units + 13 1stGreen GE

Initial Margin with Margin Offsets $481,613 = (500 x $951.50) + (13 x $451)

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) DLV

Burghardt, Galen

The Eurodollar Futures and Options Handbook, McGraw-Hill, 2003

Burghardt, Galen, et al

The Treasury Bond Basis, 3rdEdition, McGraw-Hill, 2005

CME ClearingMargins -- http://www.cmegroup.com/clearing/margins/#e=all&a=all&p=all

CME Group

Eurodollar Futures: The Basicshttp://www.cmegroup.com/trading/interest-rates/files/eurodollar-futures-the-basics.pdf

CME GroupGlobex Trade Match Algorithmshttp://www.cmegroup.com/confluence/display/EPICSANDBOX/GCC+Product+Reference+Sheet

http://www.cmegroup.com/confluence/display/EPICSANDBOX/Matching+Algorithms

CQGIntegrated Clienthttp://www.cqg.com/Products/CQG-Integrated-Client.aspx

http://www.cqg.com/Electronic-Trading/Features/Spread-Trading-in-CQG.aspx

Trading TechnologiesAutospreader

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 Bhttp://www.law.cornell.edu/cfr/text/31/356


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Done, with gratitude

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2013 CME G All i ht d 2013 CME G All i ht d

Disclaimer

40

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 contracts 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 ofthose 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 contracts 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 or itsaffiliates.

CME Group is a trademark of CME Group Inc. The Globe Logo, CME, Globex and Chicago Mercantile Exchange are trademarks of

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Chicago, Inc. NYMEX, New York Mercantile Exchange and ClearPort are registered trademarks of New York Mercantile Exchange,

Inc. COMEX is a trademark of Commodity Exchange, Inc. KCBOT, KCBT and Kansas City Board of Trade are trademarks of The

Board of Trade of Kansas City, Missouri, Inc. All other trademarks are the property of their respective owners.

The information within this 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.

us ted spread (1)

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