The Panel Says

A couple weeks back we made mention of a little-noticed event that was creeping ever closer on the calendar. If you forgot, its right here {09.30.10}. The event is the final release of Obama's Committee on Deficits, however we got a sneak peak a couple days ago. {Go here to read it in its entirety}

Here's the link to the Bloomberg write up. But let me summarize a couple of points. Just as Applegate predicted, they recommended pushing the retirement age 68 and eventually 69 {even if it is as late as 2075}. The CoD suggested eliminating various tax credits or breaks on things such as mortgage interest while lowering top tier income taxes from 35% to 23%. HUH?

Yeah, not only are they suggesting that the Federal Government lower taxes to balance the budget, they have actually stuck a cap on the total amount of receipts they can collect. Yep, that's right. The Feds can only collect receipts less than 21% of GDP. Its hard to bail the water out of a sinking ship when then hull is shattered and being held together with knitting yard.

For a fantastic read on the subject matter, swing over to The Conscience of a Liberal by Paul Krugman at the NY Times. He's a better writer anyway. Just glad to say we saw part of it coming...

~LH

Sizing up my opponent

Mid-September and I have plenty of irons in the fire. Yet the daily grind in the Fed Funds is slow and sometimes arduous.  The idea of growing our single accounts into a larger, more macro-focused trading vehicle has begun to effect my thoughts and the process by which I believe trade creation occurs. The Greek philosopher Heraclitus wrote, "Nothing endures but change." {We often hear it translated just a bit differently as, "Change is the only constant."} My newer approach is to pull back from the one tree from which I'm picking apples and take a look around me to see if there is any low-hanging fruit on another trees nearby. Why strain for the next marginal piece of fruit in my tree when there is a perfectly good piece of easy fruit on the tree right next to you? All that to say, I want to expand the book and create a greater exposure and presence markets that relate to the FF.

I've been at this long enough to know that most of my trades don't just appear out of nothing. A majority are created out of a calculated premise, a lengthy discussion and the intangible of experience. However, if we are to aim towards a more macro goal, I think the process can shift to a round table conversation where we answer the following questions:

1. Where do I think we're going tomorrow in the products that we trade?
2. What is the best trade for tomorrow?
3. What is the best trade for the next few weeks {3-6}?
4. What is the best trade for the quarter?

 I don't necessarily have the answers to any {all} of those questions at any given point, but collectively the answers will emerge. What I've described is the goal. How we actually go about getting to that point; well that's the adventure.

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I want to shift gears a bit and just briefly lay out some of the trades we've been working on over the last few weeks and months.

• In the FF we've been selling the 87/93 call spreads in December and February. We've been able to collect between .75 and 1 tick {1 tick = $41.67} and though they aren't "make your month" trades, they do help us finance our other positions.
• We've sold the March 68/75/81 put tree {-1, -1, +1} and collected an average of 1 tick. This trade leaves us short two downside puts and long one put that is currently ATM. If nothing happens in the Fed's policies or rates for the next few months OR we move higher in price {lower yields} we will simply collect our tick and be done with it. If however, we start to move lower, we're long a put spread with 1 naked short put below. The break even for this trade is roughly 9961.
• We've also done the May 68/75/81 put tree as describe above. However, we were able to collect an average of 2.75 ticks to sell the two legs and buy the one. The thought process and the theoretical payout is very similar.
• We have purchased the EDH {March 11} 92/95 {9925/9950} put spread in the Euro Dollars. Partially as a hedge against our FF put trees and partly to allow some credit risk exposure. Our thinking was if another European nation even hints at some type of sovereign wealth issue, the ED will react much more violently than the FF. We paid an average of 4.5 ticks {1 tick = $25}. The maximum this trade is worth is 25 ticks {less entry costs} giving us a very nice 5x1 on our money if it hits.

As far as what is out there but not quite ripe enough to pick? I think that the NOB is getting very attractive as a short position. The yield curve has been pricing in some type of QE2 coming out of tomorrow's FOMC meeting just as they did back in August. However, I find it difficult to believe that they will announce any type of easing coming out of an FOMC meeting. Perhaps they tweak the language, but nothing more. The chart below shows the generic NOB contract as generated by the CME. From its last top to the most recent bottom was nearly 80 ticks. At $156 per tick, that's a profit of ~$6,000 per one lot. I'm not sure how to best capture the pricing currently in the market. My gut says to get long USX {30 year Nov} put spreads and sell TYX put spreads for near zero cash outlay.

 ~LH

"Failure is an orphan"

"...but Success has a thousand fathers."

I'd love to take the credit for calling out Wednesday's TY Note auction results and our two plays that netted 87.5% and 69% profits respectively {Highlighted in our last post}. I would love to be that guy, but alas...it was Mr. Practical Thinker.

Mr. Practical Thinker fathered the notion that the market would soundly reject a 4% yield in the TY. He was dead-nuts right. Looking into the Bloomberg article further we found a few points to be encouraging in terms of our pre-auction market analysis.

1. Indirect bidders {read: Foreign Banks} accounted for 8% more of the bids than they did in March. This is encouraging because we see this as a trade that has been initiated out of necessity. There seems to be  real risks in terms of the murky EU situation(s) and US economic recovery and the idea of locking up 50-100mm at close to 4% is a really nice hedge. 
2. The bid-to-cover ratio was 3.72 vs a rolling average of 2.87. Bloomberg cites that this was the most over-subscribed auction since at least 1994. Savvy investors of all backgrounds seemed to be able to identify how lucrative it was to get in on the nearly 4% yields.
3. "The Fed's preferred inflation measure, {Core PCE} an index based on consumer purchases of goods and services excluding food and energy, was up 1.3% in February from a year earlier, below the Fed's Target of 1.5% to 2%."* If treasury buyers are looking for a reason to get long, they have found it in the fact the real inflation is at generational lows. In our opinion, the fact that investors wont get your entire return gobbled up by inflation, coupled with the notion of nearly 4% yield brought additional buyers to the marketplace.

Here's what we're thinking. The $13 billion auction of 30 Year Bonds will be good, but NOT as good as the yesterday's TY. However, yields will drift lower as futures trade higher. We're looking for opportunities to buy TY and US put spreads as well as possibly cherry-picking some cheap volatility trades. Unfortunately, you will probably have to wait until mid-day on Friday {or maybe even Monday} to get the best levels on these trades. In the TY we suggest buying a put between 112 and 114 and financing it a put {or 2} lower than 110.5. For the US contract, we suggest buying a put between 113 and 110 and selling a lower strike.

~LH

*Wall Street Journal, "Fed Fear: Raising Rates Too Soon" by Hilsenrath 04.07.2010