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STIR STIR futures are unique amongst financial markets in that they have many different expiry months trading simultaneously as part of the same contract. For example, a STIR future such as the CME Eurodollar can have as many as 40 different quarterly expiries trading at the same time. All of these expiries are based on the same STIR future, and will have the same specifications, but will differ slightly in that they all have different expiries and so their prices will change at slightly differing rates according to underlying drivers such as changes in the term structure of interest rates. Interest Rate Futures • STIRs are one of the largest financial markets in the world. The two largest contracts, the Eurodollar (US 3 month interest rates) and Euribor (European 3 month interest rates) regularly trade in excess of two trillion dollars and euros a day • The STIRs futures markets are fully computerised • STIR futures are one of the lowest risk financial futures contracts and trading spreads or similar strategies provides an even lower risk profile • STIR futures are essentially financial building blocks which makes them very suitable for trading against each other or other interest rate contracts. Introduction to STIR futures • Traded on regulated exchanges that provide legal framework, contract specifications and the trading mechanism. • Settled via a central counterparty to remove credit risk between market participants • Characterised by a unit of trading, tick size and settlement procedures. Differences from other future contracts • Multiple delivery cycles, sequential to several years, covering a broad spectrum of the near dated yield curve. • Highly similar risk characteristics between delivery cycles • Include spread trading and other trading strategies, allowing many different trade permutations and ideas, with different risk profiles. • Most liquid class of futures by nominal value Derived from interest rates • Futures are broadly classed as derivatives since they are derived from another product and are called futures since they are not for immediate purchase or sale but at a future date • STIR futures are derived from interest rates covering a deposit period of three months, extending forward from three months up to ten years. Contracts structure and general specifications • The selling and buying of STIR futures represent a notional borrowing or lending from the money markets. They confer the borrowing or lending at a rate determined by the price at which the future was transacted, for a period of 3 months • The futures are notional in the sense that they are cash settled. The futures will mirror movements in the underlying market and provide a representative profit or loss Expiry Cycle • Each stir future has a finite life and trades on a quarterly expiration cycle; March, June, September and December (H,M,U,Z) • The year is usually added to these symbols so that the cycle in 2014 would be H4,M4,U4,Z4 Serial months in between do exist but are mainly aimed at Option traders • Front 4 contracts are known as whites, next four are known as Reds, then Green. Unit of trading • The trading specifications of all contracts can be found on the individual Exchange websites. • The unit of trading is the notional value attached to each stir future, normally in denominations of one million or £500,000. Unit of trading • This unit of trading is the notional amount that would be nominally deposited or borrowed for three months. • Euribor has a nominal value of 1M euros and this value is used to calculate its minimum movement:– 1,000,000x(0.005/100)x1/4=12.50 euros – A basis point is 1/100th of one percent. Quote and tick sizes • Stir futures trade as a quote of 100 minus the interest rate. For example if interest rates were 4.5% then the outright future is quoted as 95.50 • The smallest permitted increment is known as the minimum price movement (tick) and is expressed in basis points Price Quotes Month Symbol Bid Offer Last Vol Chg Sep 14 U4 99.180 99.185 99.180 40555 0.01 Dec 14 Z4 99.055 99.060 99.055 30667 0.02 Mar 14 H4 98.840 98.845 98.845 28909 0.02 Jun14 M4 98.460 98.465 98.465 18909 0.02 Bid/offer spread • The notable difference with the quotes is the bid/offer spread • The difference between the bid price and the offer price usually reduces to the minimum price movement (tick). Last Price and volume • The last price shows where business is currently being transacted. • The volume shows the liquidity in the market. In our example the combined four quarterly months have traded 119,040 being just over 119 billion of notional interest rate trade Buying and selling STIR futures and spreads • Principles of buying/selling STIRs are similar to those of stocks, bonds or commodities. • Buy low, sell high returns a profit!! • The profit/loss on any stir future or spread can be calculated as:– No of contracts x difference in open and closing price x tick value – Eg buy 100 euribor for 98.815 and sell 98.830 generates p&l:100 x 3 (½ )TICKS x 12.5eur = 3,750 euros Spreads • A spread is simply the differential between two expiries, creating by buying and selling another • Eg U4 future can be purchased for 99.180 and a Z4 future sold in equal qty at 99.060. 99.180 – 99.060 = 0.120 • Market terminology dictates this spread prices is known as 12’s as it refers to 12 basis points difference between the two outrights. • This would be known as a 3 month spread • Nearest contract always quoted first in calculation. Futures Symbol Bid Offer Mar Jun Sep Dec H4 M4 U4 Z4 99.690 99.645 98.590 98.510 99.695 99.650 98.595 98.515 Strategy Symbol Bid Offer 3mth sp 3mth sp 6mth sp Butterfly H4M4 M4U4 H4U4 H4M4U4 0.045 0.055 0.100 -0.015 0.050 0.060 0.105 -0.005 Spread characteristics • A calendar spread with a larger interval between component delivery months will be more volatile than one with a shorter interval • Shorter interval spreads tend to be more liquid than longer interval spreads • White pack spreads will be more volatile than red pack spreads, which in turn will be more volatile than greens • Margin requirements will be higher on longer interval spreads and on white pack spreads SPREAD FACTS • • • • • Simultaneously long and short Hedged Lower margin More ways to win More time to work out • Trading the mathematical difference between 2 outrights • Spreading takes advantage of lower risk Yield Curves • Is a graph showing the range of interest rates available to investors. It is a graphic representation of market yield for a fixed income security plotted against the maturity of the security. Positive Yield Curve Flat Yield Curve Negative/Inverted Yield Curve Steep Yield Curve Yield curve effect on calendar spreads • A steepening yield curve refers to the widening of the difference between longer term yield and a shorter term yield and will cause spreads to widen • A flattening curve refers to a narrowing of the difference between a longer term yield and a shorter term yield and this will cause the calendar spreads to narrow Yield curve and calendar spreads • Yield curve steepening= Calendar spreads up • Yield curve flattening= Calendar spreads down Bund & 10 Year Treasury Note Watching • The German Govt 10 yr Debt future is known as the Bund • Many traders watch the Bund and 10 Yr Treasury Note (T Note)very closely to determine the likely direction of STIR spreads. • Due to the inverted nature of how the Bund & T Note trades, a decrease in the price of the bund indicates that the yield of the 10 Yr debt is increasing. • This increase in the yield indicates that the spreads of the front white spreads are likely to increase in value A General overview of market movement Bund Movement STIR spreads Up Front White spreads down Red Spreads Up Front white spreads Up Red Spreads Down Down Credit Spread • Credit spreads are the spreads between assets of different credit class. • Govt bonds such as German Schatz, Bobl and Bund have the highest credit rating and lowest credit risk of any class of security. • STIR futures are based on the inter-bank market and are of a lower credit rating. Economic Data • Retail Sales- RS are a monthly report of consumer spending. A lower than consensus report will tend to cause the STIR futures to increase, indicating economic weakness. • Consumer Price Index- CPI is the most popular measure of inflation in retail good svcs. Lower figures will boost the markets whilst a higher number will infer higher interest rates since the majority of central banks target inflation. • Producer Price Index- PPI is like CPI but measures the change in prices paid. Same effect on the markets as CPI. • Industrial Production-Monthly figure of industrial output European Figures • GDP-Gross Domestic Product – Measures how quickly an economy is growing. A weaker than expected figure will tend to cause future prices to increase, to stimulate the economy. Bear in mind that the quarterly GDP lags other monthly indicators, meaning market may have already factored this in. • German ZEW economic sentiment indicator – The ZEW is released monthly, usually on the 2nd or 3rd Tuesday of the month. Up to 350 financial experts take part in the survey and the indicator reflects the difference between the share of analysts that are optimistic and the share of analysts that are pessimistic for the expected economic development in Germany over the next 6mths. • German IFO Business Survey – It is a predictive indicator of the economic performance based upon survey answers from 7000 German business leaders in the main sectors of manufacturing, retail, construction and wholesale. The expectations component is a forward looking indicator of industrial production and has a good history of forecasting changes. US Figures • Non Farm Payroll – Most closely watched figure in the world. Is usually released on the first Friday of each month and is a barometer of whether the US economy is creating jobs or not. • University of Michigan Sentiment– Is a private indicator of consumer attitudes on the business climate, personal finance and retail, reflecting sample of 500 individuals. It is regarded as a superior consumer confidence figure, and tends to be a more closely watched figure at turning points in the economy. • Durable Goods – Monthly figure based on future manufacturing activity. Important as it is forward looking indicator gauging production in the months ahead. It can be one of the numbers to indicate a forthcoming change in the state of the economy. • Consumer Confidence – Another indicator of consumer outlook. Differs from Uni of Michigan in that it concentrates more on attitudes to employment and is drawn from a new sample each month. Economic Release Country Higher than Lower than forecast forecast Market effect ranking Non Farm US Payroll DOWN UP High US jobless US claims UP DOWN Low GDP ALL DOWN UP Med/Low Retail Sales ALL DOWN UP High CPI ALL DOWN UP High Economic Release Country Higher than forecast Lower than forecast Market effect ranking PPI ALL DOWN UP Med High PMI ALL DOWN UP Med Consumer confidence US DOWN UP Med High Michigan US DOWN UP Med High Durable goods US DOWN Ind prod ALL DOWN UP Med Housing ALL DOWN UP Med UP Med