Wednesday, June 15, 2011

Playing a possible liquidity squeeze?

From a broker today saying his guys saw unusual flow on the floor in Eurodollar (ED) put options.

A large market player bought around 40k contracts (USD 40 billion in notion, 3m FRA), 5k/quarterly expiration, strike 95.00 puts, out to 2013.

With USD rates as low as they are and for so long I can affirm implied volatility has been low despite recent vol events (may-jun and dec last year).
Now imagine what happens if the european sovereign debt issue strains short-term liquidity for banks?

Last year we saw a decent move in TED-Spreads and short-dated ED rates.

If we see a repeat this year, with rates moving up, volatility will spike up and this trade could be a huge winner.
I like this idea, but again, this is playing against central banks who can provide lots of liquidity very quickly. I lost money on a similar trade last year. Thank you Trichet. 

Still good risk-reward in my opinion.

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

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