Update

So there you have it. I guess it was sort of a push? I got 3 right, he got 3 right...but to be fair, my S&P call was pretty good too! However, since the X {November Fed Fund} market was technically Mr. Practical Thinker's, I assume that I owe lunch for the office.

~LH

Nostradamus

With Mr. Practical Thinker heading off to the Holy Lands today the Old Baron and myself decided to play Nostradamus and predict where the world would all be at upon his return.

The one with the most losses, buys lunch for the office.

~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

Confucius say ...

"He who pick bottom, get stinky finger" (perhaps my favorite 'market timing' quote--obviously not Confucius)

Friday was a very abbreviated session that gave the credit markets a quick and solid beat down. Not only did every interest rate product move lower, but the spreads started moving as well (as opposed to the unilateral moves we've had recently)

To us, this signals a good sign. The marketplace is finally starting to price in a recovering US economy and all of the impending policy maneuvers that will accompany this revival.

Here's a few points of interest:

• As of the close yesterday, the Fed Fund Futures were pricing in a 43% chance of a 50 bps rate move at the January 2011 meeting. (Also known as an 86% chance of a 25 bps hike)
• Our closely watched NOB (Notes over Bonds) yield spread touched 86 bps on Friday. In the full session yesterday (Monday 4.05.10), it did NOT react as we had expected. Recently, when the short end (ED and 2 Yr Notes) sell off, the NOB goes negative (in relative terms, the 10's are underperforming in relationship to the 30's and the spread between their yields is increasing) Yesterday, even with a aggressive sell in the futures market, the NOB stayed constant at 88-89 bps. This signaled to us that the market wasn't fully convinced that yields were headed higher. Early price action today, confirms that assumption as they are drifting higher in early trade.
• General market consensus is that this week's auctions (all 8 of them ranging from 4 weeks to 30 years) will be met with mixed demand. Most talking heads have been harping on higher interest rates due to investors REQUIRING more bang for their buck. We disagree. Foreign investors were quiet at the last few rounds of auctions as they sifted out the mixture of data coming from the US. We anticipate very robust auctions and a drop in current yields (especially in the TY and US contracts).

We got long the following:

1. In the Ten Year (TY) we bought the 116.5 - 117.5 call spread for 8 ticks. Risk is 8 ticks, potential profit is 56 ticks (64-8). We're looking for a good TY auction on Wednesday and will probably be out around 14-16. {SOLD OUT AT 15 vs. 115.30 TYM10 Netting 87.5% profit}
2. In the 30 Yr Bond (US) we're long the 116-117 call spread for 13. Same parameters, just looking for a pop.{SOLD OUT AT 22 vs. 115.21 in USM10 Netting 69% profit}
3. We're still hedged up for a move to the downside in the Euro Dollar (ED). We still have the E0K 9837.5 - 9812.5 put spread 1x2 on for a half a tick. We're long the 9837.5s to be short 2X the 9812.5s. This trade pays off if the June 2011 ED settles below 9837.5 on May14th.
4. We took off the E0J put spread 1x2 for a 75% profit.

Closing thought:

• A large hedge fund in Greenwich CT. initiated a US 117 - 119 call spread 1x2 this morning. They bought the 117 calls and sold 2X 119 calls. They did 15K (15,000 x 30,000)! In my opinion, they have the same thoughts as us. The only difference is the timing (We put all of ours on yesterday) and size (We didn't do 15K)

This is the week of supply.

~LH

Excution Update

*Click the title.*

~LH

Pre-Unemployment

I've had a couple of interesting and unique bosses and partners in the past. I've always tried to glean the good and leave the rest in an attempt to become a more successful trader. 

I vividly remember watching the futility of my first boss because he wasn't part of the system. I never could understand why this large, former NFL'er, with a booming baritone voice was only given 5 lots when meek, little guys around him were getting fed 50s or 100s. He could physically beat anyone in that pit into a fine sawdust, but was a third (or fourth) tier trader. Why? The system, I later learned, was the act of "paying for information." You throw the broker's a bone or two in terms of a very easily filled trade and they reciprocate by upping your quantities on the juicy trades that they have control over.

Now that I've made the transistion from the pits to the screen, this game becomes ever more important. I need brokers to fill in the color that I was once able to see from the pit. I want them to show me ALL their players, not just the big 3. I require more than just an IM or an email: I require substance. And my weapon of choice to get it? I pass out brokerage checks to a small army of individuals in hopes that each one will add a little bit more to my market picture.

Tonight, as I'm enjoying a late dinner with friends, one of these brokers sent me a press release out of Barclays Capital. I had been game-planning for tomorrow's number while trying to take in some of the very unique circumstances that this number will encompass. The most striking of these is the mere 45 minutes that the market will have to digest it before the S&P 500 futures close down for the holiday weekend. This means that the move could have the potential to be violent! 

• Per Barclays Capital Report Pg 1 & 3, Dated 1 April 2010

Employment report (8:30am): We expect a strong March employment report, with nonfarm payrolls up 250k and the unemployment rate down a tenth, to 9.6% (consensus: payrolls 184k, unemployment 9.7%). We and the consensus also expect the average workweek to edge higher to 33.9 from 33.8. Much of this sharp gain would be transitory, as it reflects the combination of a weather payback and Census 2010 hiring. On the former, we believe that the inclement weather in February subtracted about 75k from payrolls and pulled down the workweek, particularly in the construction and manufacturing sector. We expect this to be reversed in March. On the latter, we expect the Census Bureau to hire about 125k workers in March, which would show up as a boost to federal non-postal payrolls. This implies an "underlying" gain of roughly 50K jobs. Census hiring should continue to ramp up, likely peaking in May at more than 500k additional jobs. However, these jobs are temporary and will be removed from the statistics in the summer and translate to a net job loss.

If the scenario plays out as they suggest and we add 250K jobs, the credit markets will demand higher yields and the equities will blast off. I was roundly mocked in my office for suggesting that the one day , ATM straddle for the S&P should be 17.00-20.00 based on today's close. But, if there isn't a lot of time to finesse your bids throughout a trading day...LOOK OUT.

Barclays suggested one other very interesting tidbit.

Vols richened, probably due to rise in longer rates. 3m swaptions were marked ~4abpv higher. Have vols formed a bottom and now start rising? We think not: there is simply too much supply than what dealers can find a home for. In March, the option market digested roughly $30mn vega from new issuance in zero coupon and agency callable notes. This is more than what it had to deal with in the previous two months. Without realized vol and demand from mortgage hedgers, lower is probably still the path of least resistance for vols.

A massive amount of this Vega was sold via PIMCO and its cohorts for yield enhancement on their bond/mortgage portfolios. And though we've had a very nice pop in Vol over the last 2 weeks (TY June ATM straddles went from 2.03 to 2.23 representing a .5% rise in option vol) they are calling for this to be nothing more than a momentary blip. I can actually see their logic and have begun to change my thought process about getting long Bond Vols, even if I can buy them at sub 8% prices...

All this to say. I'm going to bed and looking forward to a whip-sawed, fast paced day with light volume and only one direction.

~LH

One play for today (3.31.10)

Haven't written in awhile and I feel naked. Let's open the playbook. Who has an idea to pitch me?

ANYONE?

• Bonds: I'm looking for a sharp down draft (lower prices, higher yields) on Friday's Unemployment data. Wednesday's ADP data was shocking to say the least. The market gurus were predicting an increase in hiring (not a loss) and are also whispering about a +200-250K job number this Friday. I don't think that +200K will happen (Bloomberg wants +181K), but it could and the 'Census Hiring' could be the determining factor. Due to the run up in Yield Curve Futures today we were able to buy the Ten Year 113.5-114.5 put spread in May for 7 ticks (TYK 13+/14+). (Updated: 4.2.10: The Unemployment Report broke us a bit lower. We looked at and discussed the possibilities of rolling it into a NOB. However, the yield spread between the 10's and 30's is not at a level we felt comfortable initiating. Therefore, we simply sold our entire position at 12 ticks. Netting 5 ticks of profit)
• You have 2 plays with this spread as we cruise lower. Sell it out and take your 4-5 ticks OR sell the May 112-113 put spread in the BONDS on a 100:-65 ratio (ie sell 65 Bond spreads per 100 Ten Years)
• Option 2 actually allows you to collect a small amount of premium and to effectively have an NOB (Notes over Bonds) yield spread play on. 

~LH

Quoting Pixar

Some weeks are harder than others. Last week was one of those weeks. Whether its the difficulties of a trending market or perhaps the pinch of repeatedly bad settlements it is with eager anticipation that I look forward to this new week. 

I desperately need to get Mr. Practical Thinker to write a piece or two on here. However, until he does, I will continue to poach his macro-mindedness and translate it into something we can all glean wisdom from. 

"You provide the food, I'll provide the perspective..."  (Anton Ego, Ratatoille)

This is not the first time I've stolen a line from Ratatoille (shameless plug: rent, borrow or buy this movie because its dialogue is supreme) and I hope broaden my "quotage" in the weeks to come but for now, you're stuck with the genius of Pixar. 

All this to say...the rumor-mongers and Mr. PT have done some adjusted my thinking by providing the perspective. If you've been following our execution you might have noticed that one trade we've gotten consistently right is our NOB (Notes Over Bonds) where we have sold the yield spread as it approached 100 basis points. On Friday, the spread between the two dipped to (and closed at) 89 bps and I desperately wanted to get long for the ride back up. 


The discussion was poignant and chalk full of salient information, but there were two quotes that I absolutely have to put on here. 

"I want to stay in a trade until it is blatantly obvious that I should have it on the other way"

 Two weeks ago, the NOB yield spread was trading 98bps and we sold it. If we (US) are really heading towards slightly higher short term rates and a better overall economic picture, one would expect a flattening yield curve. Why would we be in a hurry to tap out of at 90 or for that matter get long hoping to chop the last few basis points off of the giant's spear? Given where we believe the curve's rates are headed, we should have bet the farm at 98, looked to continue selling at 94, staying alert for any type of momentary blip while we continued to sell it until the 3 month low of 82 is taken out or we're so ultimately convinced that it is heading the other direction that we're forced to cover. Why would I give up on the right play? I think the answer lies within the Old Barron's wisdom of quote #2:

"It is so hard to stay long a winning trade, especially in this current trading climate."
That is so true. We're currently an office of grinders. We sit and grind through spread after spread, buying and selling both bids and offers while trying to not internalize to much of a position. Our ability to see the next tree and articulately describe it, inhibits our skill at seeing the actual forest. We are miss the global plays because we have our heads down and are furiously working at pounding out ticks. Though there is great wealth in "the grind," my guts says that the real money is in the being able to identify the trading climate you're headed towards and position yourself appropriately. Our tendency with winners is to close them out as soon as we've reached the maximum we were willing to lose. But trading isn't a bell-shaped curve. The best trades are great even if they retrace a bit and cause you to re-evaluate why you got into the position in the first place. Does the this particular trading strategy still hold water? If yes, you'll have to resist the temptation to close out and risk your chips a bit longer.


Needless to say, I didn't NOB it up. I'm actually flat. 


~LH

The tales of the tape

I've been called a bunch of stuff during my tenure as a trader (most of which are not postable due to the explicit nature of the floor). I have a thick shell and frankly nothing really stuck...with one exception. I've been told that I gossip like a school girl and can not pass up a good story, especial when it involves trading.

Today was my lucky day, I got to hear two fantastic tales from fellow traders.

1. Chicago is the home of some of the industry's powerhouse operations. Some you know because of their reputations, others you might have seen advertising on TV, and others you know only because of their secrecy . This is a story about one of those kind of firms. These guys swing a big stick, have an ultra cryptic black box, and have been having a really rough go of things lately. In fact, through February these guys were down a whopping 16.5% on their flagship fund. Suddenly, the stars lined up (quite literally, as it has been rumored that they use employee's astrological information in their black box calculations). In the first 13 trading days of March they rebounded a shocking 29% including a 5% move TODAY. Seriously? You made 5%, today? ON WHAT?!? And wait a second, what is the beta on this portfolio: +8? Yet this trader was lamenting that even though they have just slaughtered the market (and their competitors) they are liquidating all non-essential assets. The house out west, the satellite offices around the 'burbs, even the gorgeous tropical fish aquarium in their high-rise loop office have been sold, closed, or flushed... The returns might be rosy today, but his fear (and mine too if I was an investor) is that: any thing that can appreciate 5% in one day, can depreciate equally fast. I casually asked him what sort of risk parameters they were using, if they were incorporating options in their strategies, and whether or not they (the traders) actually had any autonomy in what they were trading. His answers were baffling: No real idea (risk), No they're too costly (options), Not really--we just trade what we're told. Wow. The moral of this tale is: be careful where you invest even if the shop is local.

2. Today was St. Patty's Day and as I was enjoying a beer with some of the neighborhood folk I ran into a kindred spirit: an option trader. He trades for one of the largest, highly respected, money-making firms in the industry. They have traders on all continents, in every major trading location, and in almost every pit where there's money to be made. He admitted that 2009 was a very difficult year for him as well as the firm's floor operations. Supposedly, it was so bad that Christmas bonuses were scrapped. However, a majority of 'W2' traders are paid a relatively low base salary and receive between 33-50% of their total compensation via a year-end discretionary bonus. Yet this firm is spending millions to upgrade their office facilities. MILLIONS! The trader I spoke with said that he felt his meager bonus was negated in favor of the company's lavish new digs. In fact, he claimed that they lost over a dozen pit traders when ALL bonuses were canceled, even though some of those traders made the company so serious money (I'm guessing that some people must have been negative too if it was a difficult year for the floor ops).

These stories tell tales from two different ends of spectrum, but there's a twisted humor in both of them. Hopefully, both my acquaintances will manage to trade out of their current spots.

~LH

Semantics

OK, guess what, I was wrong the on the change in wording (#9 from my last post). They made a few minor changes, but to be honest it is window dressing and it feels like they (the Fed) is trying to tip-toe around the markets.

 Here are the highlights that I enjoyed:

LABOR MARKETS
    January: "The deterioration in the labor market is
abating."
    March: "The labor market is stabilizing."
  
ECONOMIC CONDITIONS
    January: "Household spending is expanding at a moderate
rate but remains constrained by a weak labor market, modest
income growth, lower housing wealth and tight credit."
    March: "Household spending is expanding at a moderate rate
but remains constrained by high unemployment, modest income
growth, lower housing wealth and tight credit."

DISSENT
    January: Kansas City Federal Reserve Bank President Thomas
Hoenig dissents, arguing that pledge to keep rates at
exceptionally low levels for an extended period is no longer
warranted.
    March: Hoenig again is the only Fed official to dissent

Nothing changed... well, I take that back. The outrights shot higher and the spreads conversely collapsed.

Points of interest:

• The Fimat desk continues to sell 50/56 and 56/62 put stupids in November. They also have started buying the 68/75 and 68/81 call spreads. IN MY OPINION: This is almost an identical trade to the one they executed at the end of last summer. Obviously, I have no idea what they had against it (the earlier trade) as a hedge, but if it was a stand-alone Fed Funds trade, it could have grossed a whopping 35mm. (notes from 2/28). 
• The long end of the yield curve (30s) has experienced a "volocaust" in terms of the options markets. The 30 day moving average of the underlying (USM10) is tracking around 7.5% and the options are equally as cheap. It is probably about time to get long June or September volatility. 
• I spoke with a few Energy traders this week. They all told me the same story in slightly different terms. After a really rocky '08-'09 for the Natural Gas vs Crude Oil trade, a lot of traders jumped back into it at the start of 2010. Everyone was betting long NG (because it was cheap) and short $80 Crude. However, the rise in Crude and the collapse of Natty has been a costly trade. In order to cover their losses, they've simply sold their long Nat Gas and sold more Crude short. Eww, sounds like a painful to me. (Crude is up almost $2 as I type this)
• The SPX has broken all resistance lines and is headed to 1175. I'm indifferent but need to cover some cheap puts around the 1115 line
• The NOB is at 94 bps. {aka "no man's land"}
• The Dollar looked horrible today... and the 'impending news' about Spain has never materialized
• EC continues its bullish run back towards the 1.40s. If you look at the chart on a 1-day time interval, it appears to be building the foundations for a firm support line around the 1.35-1.36 area. 

Until they're all winners, trade away.
~LH