The goal of this article is to explain the volatility yield curve trade to a certain degree. I know this might sound odd, but the trade was not entirely predicated on accurately predicting the taper even thought that is what occured. I will explain why in an article on Monday, but understand that yields were likely rising regardless.
Allow me to begin by addressing predicting the taper. I don’t want to take credit for this. I had an on the record conversation with Jay Feuerstein, CIO and founder of 2100 Xenon, who flatly called for a December taper from the Fed. Jay is an accomplished yield curve trader and is credited with helping develop the first bond futures contract and I highly respect him. After he outlined the economic rational, I heard from other hedge fund traders along the yield curve, all of whom shared the view of the December taper. Then I spoke to a DC contact who has been on the money regarding what’s really going on behind the scenes, and speculation was a Dec taper was highly likely.
I had my own reasons for thinking a Dec taper was likely, including Bernanke’s legacy and how the taper timing would be optimal during the holiday period. But also the sense I was getting was that credibility on the yield curve was eroding – and if the Fed kept up its bond buying program the market’s reputation as a mechanism to true price discovery would be badly damaged. These were reasons I thought the taper would come. If you would like to hear me engage in a casual conversation about the taper and other topics, go to this Internet video interview I conducted: https://www.youtube.com/watch?v=kzeFV5lwO9c
In regards to the trade itself, it is playing out as anticipated. Hold your position. The debit spread in the puts will have a time horizon of several months (2 or 4 depending on price action) while the credit spread in the calls could have a shorter duration (less than one month to 2 months depending on price action). Take note of the different time horizon’s selected relative to volatility expectations, I designed the trade in this regard for a specific reason. I will explain the details of the trade strategy in an article I will post on Monday.
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