Trade of a Lifetime

 | Sep 06, 2012 | 6:00 PM EDT  | Comments
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I am going out on a limb here, and if there is no change in interest rates in the next 27 months I will be wrong.

If and when rates move higher, bearish exposure in long-dated Eurodollar contracts could be the preeminent trade of my career. Not only do I see the potential for great profit, I like the outlook in regards to risk.

This is NOT the euro currency that is trading at roughly $1.26, but rather the debt instrument tied to the short end of the yield curve. As defined on the CME website: Eurodollar Time Deposit having a principal value of USD $1,000,000 with a three-month maturity. Quoted in IMM Three-Month LIBOR index points or 100 minus the rate on an annual basis over a 360 day year (e.g., a rate of 2.5% shall be quoted as 97.50). 1 basis point = .01 = $25.

 

Eurodollar
Source: QST

 

Prices appear to have reached an interim top. The current perception in this contract is rates will be approximately 0.625% in December 2014, but as the perception shifts that rates may be higher then the inverse relationship kicks in. Let's say if rates move to say 1.5% then the price in this instrument should be 100.00-1.50=98.50, or .875 ticks from the current price.

At $25 per tick that is a move of $2,187.50 per futures contract. Get this. The current margin rate is only $844/625. You are essential placing a bet that either interest rates will rise in the next 27 months, or at least the perception in the market will change, pricing in a rate increase. Not only do I think this is a high-quality gamble, let's address the risk. Let's say no change in rates and this instrument trades up to par. This would represent a loss of $1,562.50 (100-99.375=.625 or $1,562.50).

The Eurodollar futures and options are one of the most liquid instruments tradeable to commodity investors. Now it gets even better. What about at the money put options out until December 2014, more than two years away. Today's price was just over $600/per and this option has a 54% delta. A pre-defined risk as an option buyer with an attractive risk/reward dynamic, in my opinion.

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