In "Intramarket futures spreads," I explained that one of the main reasons investors use futures calendar spreads is to trade their expectations for changes in the relationships between contracts in the same market with different expirations.
The market decline on Tuesday, October 8 provided a great example of just such a trade setup. Markets began to reprice risk as the debt ceiling date looms closer with no apparent progress among House Republicans, and while equity markets had already been acting poorly for several sessions, the concern finally started to filter into short term interest rate markets. To see how much the yield curve has changed in recent days, review the attached table of constant maturity Treasury rates, focusing on the one and three month columns.
Treasury Yield Curve Rates, Oct. 8, 2013. Source: U.S. Treasury
Additionally, the attached chart shows eurodollar futures contracts traded at the CME for March 2014 and December 2014 expiration.
March 2014 and December 2014 Eurodollar futures. Source: CME, Tradestation
The March contract is displayed on top, with December below. I've highlighted the recent change in the relationship between these two contracts along with a similar episode that occurred in late June. Prices for the March contract fell more sharply than for December (equating higher yields for shorter dated securities), and the trade some professionals in Chicago were eyeing was to buy March and sell December on the expectation of a return to a more normal curve once Congress decides not to default on the U.S. debt.
Buy the GE March 2014 futures at 99.6350 and sell the GE December 2014 futures at 99.4600.
GE is the symbol for Eurodollars traded electronically on CME Globex. This trade would stand to profit if the front of the yield curve declines, as traders would make a greater profit on the March futures than they would lose on the December contract. The risk to the position would be if short term yields continued to rise. Given the uncertainty around short term market liquidity preferences, it would be smart to scale into this sort of position.
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