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Curve Flattener/Steepener

Posted: November 4th, 2011, 9:06 pm
by secret2
I have a question regarding credit or interest rate curve flattener/steepener trade. For the sake of discussion let's suppose I want to bet on the yield curve steepening by shorting 10 yr bond/longing 3 yr bond. I know that there's sliding cost in such trades because the maturity of the 10 yr bond eventually becomes 9.5 years, and so on. So, if I really want to bet on the 10yr and 5yr points on the yield curve specifically, do I need to trade something like constant maturity swaps?

Curve Flattener/Steepener

Posted: November 7th, 2011, 2:08 pm
by Martinghoul
Or you can buy a 5s10s CMS cap...

Curve Flattener/Steepener

Posted: November 8th, 2011, 11:48 am
by DavidJN
Couldn't you just roll the position into newly issued bonds when the benchmarks change? If you are using bonds, you'd need to periodically readjust the proportions when the absolute level of yields changes enough anyways.

Curve Flattener/Steepener

Posted: November 8th, 2011, 4:21 pm
by secret2
Right, I am just wondering if there's a neater way to achieve the prupose...

Curve Flattener/Steepener

Posted: November 8th, 2011, 9:30 pm
by Gmike2000
no there is not, besides, how long do you want to wait for your trade to make money? if one year is too long then maybe your timing is offalso, if you buy fancy things like cms products, they will incorporate the 'slide' and bill you implicitly for it (though the slide tends to be positive for a steepener).besides, cms products are not liquid. you need liquidity to get out of a bad trade...in a market dislocation, you will not get out of a cms product. the best trades are the simple ones. peace out.

Curve Flattener/Steepener

Posted: November 8th, 2011, 11:29 pm
by secret2
Thanks for the explanation, good to know the practical considerations involved in real trading settings.

Curve Flattener/Steepener

Posted: April 12th, 2012, 11:28 am
by IRhunter
Another way to do this would be by using swaptions with underlying the 5y and the 10y of the curve. With this way u don't have to worry about roll down and carry, of your position. Moreover, swaptions are in general very liquid products.There are many other exotic financial instruments which would give u the same position in DELTA in these two underlyings. For example you could buy or sell payers and receivers with knock out. However, in this case you should be able to manage the exposure that you have to other greeks (rather than only DELTA).

Curve Flattener/Steepener

Posted: April 12th, 2012, 11:36 am
by Martinghoul
QuoteOriginally posted by: IRhunterAnother way to do this would be by using swaptions with underlying the 5y and the 10y of the curve. With this way u don't have to worry about roll down and carry, of your position.This is extremely misguided and incorrect. Just 'cause the trade is done through swaptions doesn't mean that you don't have to "worry" about roll-down and carry.

Curve Flattener/Steepener

Posted: April 13th, 2012, 10:59 am
by Amin
QuoteOriginally posted by: Gmike2000besides, cms products are not liquid. you need liquidity to get out of a bad trade...in a market dislocation, you will not get out of a cms product. the best trades are the simple ones.How liquid are bermudan cms swaptions?

Curve Flattener/Steepener

Posted: April 13th, 2012, 12:18 pm
by BrightDay
QuoteHow liquid are bermudan cms swaptions?Clearly a rhetorical question...

Curve Flattener/Steepener

Posted: April 13th, 2012, 4:59 pm
by Amin
I asked the question in earnest. I remember when I did my thesis, I dealt with Bermudan constant tenor swaptions. They were different from regular bermudan swaptions in that they were far more sensitive to correlations between LIBOR rates when a model is properly calibrated to swaptions market. Though cms spreads were very popular before the crisis, I did not do any work on bermudan constant tenor swaptions so I really do not know about their liquidity etc. It just seemed natural to ask here.

Curve Flattener/Steepener

Posted: April 15th, 2012, 10:52 am
by IRhunter
QuoteOriginally posted by: MartinghoulQuoteOriginally posted by: IRhunterAnother way to do this would be by using swaptions with underlying the 5y and the 10y of the curve. With this way u don't have to worry about roll down and carry, of your position.This is extremely misguided and incorrect. Just 'cause the trade is done through swaptions doesn't mean that you don't have to "worry" about roll-down and carry.Roll down and carry are both linked with the fact that in IRS positions, our underlying changes as time goes on. After 1y for example my exposure will be @ 4y 9y.If I put a trade with swaptions my underlyings do not change. So, could you please be more specific regarding why this is incorrect?

Curve Flattener/Steepener

Posted: April 15th, 2012, 11:46 am
by IRhunter
QuoteOriginally posted by: AminI asked the question in earnest. I remember when I did my thesis, I dealt with Bermudan constant tenor swaptions. They were different from regular bermudan swaptions in that they were far more sensitive to correlations between LIBOR rates when a model is properly calibrated to swaptions market. Though cms spreads were very popular before the crisis, I did not do any work on bermudan constant tenor swaptions so I really do not know about their liquidity etc. It just seemed natural to ask here.I guess that to price the CMS product you used Libor Market Model to account for the correlation, and then LS algorithm to account the callability feature. Only traders with high mathematical back round can trade these exotics products, thus they are illiquid. Also, keep in mind that trading with correlation sensitive derivatives can become very tricky as implied correlation is not in general being quote in BBG or RR (like implied vol). So, most of the times the prices in OTC market vary a lot.

Curve Flattener/Steepener

Posted: April 15th, 2012, 4:35 pm
by Martinghoul
QuoteOriginally posted by: IRhunterQuoteOriginally posted by: MartinghoulQuoteOriginally posted by: IRhunterAnother way to do this would be by using swaptions with underlying the 5y and the 10y of the curve. With this way u don't have to worry about roll down and carry, of your position.This is extremely misguided and incorrect. Just 'cause the trade is done through swaptions doesn't mean that you don't have to "worry" about roll-down and carry.Roll down and carry are both linked with the fact that in IRS positions, our underlying changes as time goes on. After 1y for example my exposure will be @ 4y 9y.If I put a trade with swaptions my underlyings do not change. So, could you please be more specific regarding why this is incorrect?The fact that the underlyings for the swaptions do not change is irrelevant. A curve position expressed through swaptions is obviously still a curve position with all of its characteristics. Furthermore, given that you also have a vol position, you have the vol surface rolldown to take into account. This is very basic.

Curve Flattener/Steepener

Posted: April 15th, 2012, 11:48 pm
by wickedwit
It is incorrect because swaptions are priced off of forwards. The current Swap curve and treasury curve is positively sloped and thus has forward rates that are higher then spot or par rates (the on-the-run swap rate). So your ATM put option strike on the 10yr swap rate in 1 year will be higher then the current spot rate. In 1 yr if nothing changes and you are left with your put option (payer) it will not be at the money like it was when you struck it, it will be out of the money. So, say the current spot 10yr swap rate is 2.15, and your atm payer swaption was struck at something like 2.20, in 1yr the 10yr swap rate is still 2.15 if nothing changes and you essentially experienced the roll down.