Our markets are slow and getting increasingly cheap. A few thousand contracts here and a few hundred over there is about all we're seeing these days. ED volume has fallen to new lows in total contracts traded. It's as if the world is in a post Thanksgiving induced coma. It has been fed cheap money in infinite amounts. Now as it lays and tries to digest everything, its being lulled to sleep in an environment of sinking volatility.
I'm seen this movie before, somehow it always ends in tragedy. {However, it is only painful if you are caught holding the potato when the music stops.}
Few of the things we would like to do.
1. ZH diagonals in the TY and US. I would like to grab some cheaper gamma and finance it by selling wings. Ideally, we would like to do this with puts. Our medium term outlook {3-6 months} is that we'll stay range bound in the yield curve with moderate moves within the range that will help you to finance your decay. {Z28p v H21p gives you positive 6.5 gamma for 2.75 ticks of decay a day}In the event of a credit meltdown, we suspect the bonds will go higher, making a short longer dated call a risk to your overall position.
2. In order to capture the 'cheapness' of implied risk, we think that you're best served putting on steepeners across products in FF v ED {sell the ED and buy the FF}. Of particular interest to us is the EDU v FFU. The spread between the two of them has recent traded at its low {28} and it provides a couple of plays as we go forward. a) if the world ever gets frightened by credit risk, European or American GDP, or some other nascent economics flag you'll most likely see the EDU react in a much more violent way then the FFU. b) under current decay models, the EDZ v FFZ is at 17 with a QE2 bump priced in. This means you have a pretty solid floor at -9, though we are looking at a stop around the 24 range and an anticipated exit at 40.
3. We still like being short the NOB. If you can stomach the stress, it has a long way to fall back towards reality.
~LH
