Post by account_disabled on Feb 25, 2024 2:26:49 GMT -5
Everyone knows that that particular mess won't happen again, but They're sniffing. They look for an analogous disaster, so they can avoid it, profit from it, or (in the case of people like me) look smart by noticing the problem before it explodes and then writing a book about it. Lately, people are watching with trepidation (or is it anticipation?) the basis trading of Treasuries. The Treasury market is a good target for anxiety. It nearly failed in 2020, when volatility spiked, liquidity disappeared, and the Federal Reserve had to intervene. One of the culprits for this could have been speculators who had taken advantage of exposure to Treasury bonds that they had to quickly unload. Basis trading is one form this speculation takes. It works like this. I sell a lot of futures contracts; That is, I agree to buy a lot of Treasuries at a certain price, for the sake of simplicity, let's call it at some point in the future.
Let's call it three months. Now I buy a bunch of Treasuries for $100 (why are futures more expensive than cash Treasuries? Mainly because there is a lot of demand for futures to use for hedging interest rates). At the end of Job Function Email Database the three months, I close the futures trade, providing my $100 Treasury in exchange for $100.50. I made 50 cents. Hurrah. The good thing about this trade is that it is even. In general, I don't care what happens to the price of Treasury bonds or Treasury futures over the life of the trade. All I have to do is hold the Treasure and then deliver it as specified in the contract. The problem is that 50 cents is not an attractive return on a trade that ties up for three months. It's not as good as simply buying a Treasury bill. But because the trade is even (it's almost pure arbitrage), I can borrow tons of money to set it up. Even more so because it is based on Treasury bonds, the risk-free asset.
Performance starts to look good, even when you subtract the cost of all leverage. But leverage makes the trade risky, as an excellent 2020 report from the Office of Financial Research explains. The first problem is that trades are typically financed in the overnight “repo” market, and if rates move and this financing becomes more expensive, it can wipe out the profits on the trade, and then some, forcing me to close the operation in a hurry. What's more, if Treasury bond or Treasury futures prices move, I have to post additional margin with my lender or futures clearinghouse. As long as they move in the same direction, I'm pretty good, because when one requires more margin, the other will require less. However, if they move in different directions, I have to get out as quickly as I can. When any of the risks hit, I sell my Treasuries in a hurry.
Let's call it three months. Now I buy a bunch of Treasuries for $100 (why are futures more expensive than cash Treasuries? Mainly because there is a lot of demand for futures to use for hedging interest rates). At the end of Job Function Email Database the three months, I close the futures trade, providing my $100 Treasury in exchange for $100.50. I made 50 cents. Hurrah. The good thing about this trade is that it is even. In general, I don't care what happens to the price of Treasury bonds or Treasury futures over the life of the trade. All I have to do is hold the Treasure and then deliver it as specified in the contract. The problem is that 50 cents is not an attractive return on a trade that ties up for three months. It's not as good as simply buying a Treasury bill. But because the trade is even (it's almost pure arbitrage), I can borrow tons of money to set it up. Even more so because it is based on Treasury bonds, the risk-free asset.
Performance starts to look good, even when you subtract the cost of all leverage. But leverage makes the trade risky, as an excellent 2020 report from the Office of Financial Research explains. The first problem is that trades are typically financed in the overnight “repo” market, and if rates move and this financing becomes more expensive, it can wipe out the profits on the trade, and then some, forcing me to close the operation in a hurry. What's more, if Treasury bond or Treasury futures prices move, I have to post additional margin with my lender or futures clearinghouse. As long as they move in the same direction, I'm pretty good, because when one requires more margin, the other will require less. However, if they move in different directions, I have to get out as quickly as I can. When any of the risks hit, I sell my Treasuries in a hurry.