LTTF and the Eurodollar Futures

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M20J
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LTTF and the Eurodollar Futures

Post by M20J » Wed Apr 08, 2009 8:11 am

Here's a question I'm not sure how to backtest.

It's somewhat difficult for the Eurodollar futures to now develop a meaningful long-term uptrend. You could theoretically squeeze another point out of them, but that's it. With the downside risk now so significant relative to the potential upside reward, should buy signals from LTTF systems be ignored?

Regards,
David

Demon

Post by Demon » Wed Apr 08, 2009 9:54 am

What happens if we do get a meaningful dose of deflation?

sluggo
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Post by sluggo » Wed Apr 08, 2009 10:08 am

The Chicago Mercantile Exchange's Eurodollar contract has a cousin in London called the EURIBOR contract. The first few lines of their Specifications are shown below.

Perhaps nervous ED traders might wish to transfer their loyalty to the FEI, whose price chart seems not to exhibit a ceiling of overhead resistance. At least not yet.
Attachments
Specs.png
From the CME and Euronext websites
Specs.png (18.62 KiB) Viewed 4977 times
STIR_contracts.png
plotted from the Blox "Chart" system
STIR_contracts.png (22.63 KiB) Viewed 4977 times

M20J
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Post by M20J » Thu Apr 09, 2009 3:31 am

Darran - I'm not sure where you're coming from with the deflation comment - perhaps you could explain. In a deflationary environment it seems to me you'd be much better off short commodities than long Eurodollars.

Sluggo - they're only cousins, rather than brothers, but both contracts do suffer from the same cap at 100 - unless I've grossly misunderstood something (please correct me if I have). With both contracts reflecting (100 - LIBOR), they're mainly sensitive to the level of risk-free interest rates and the credit spread on AA banks. There's only so low either of those can go. EURIBOR is only still heading downwards because EURO interest rates are significantly higher than USD ones, with potential and expectations for further cuts.

To my mind, LTTF is fundamentally about discerning long-term trends and hanging on for the big moves. If the contract can't go any higher than 100, there's a limited reward to be extracted. Of course, we all know theoretically we're all interested in percentage moves rather than absolute ones, but it seems to me there is little to be gained relative to the possible downside. The contract is currently around 99 and has recently been below 98.5. So you could quite conceivably be given a signal with a 0.5 point downside risk, but a 1 point maximum upside if interest rates and credit spreads go to zero. That's hardly hanging on for the big move.

If this was, say, an oil contract, a break through the peak at 99.25 might signal a move to 150 or beyond. Because this contract is capped at 100, there's no chance of this with the Eurodollar contract. I don't know about your systems, but mine just treat both as time series of prices and don't know the difference between them. There's nowhere in my LTTF system that knows the Eurodollar contract can't go above 100 whereas an oil one can.

This brings to mind two questions:

1) In the short term, should I override any long Eurodollar signals from my naive LTTF system because I know something detrimental to the trade that it doesn't?

2) In the longer term, is there any way of improving the system so that it knows about the cap, and is there any way of backtesting such a change given that this is a rare occurrence?

It would be interesting to compare notes with people who run LTTF systems on stocks, for which there's a lot more data around barrier levels. Would they, perhaps, ignore a new sell signal for CitiGroup when it's already trading at $1?

Regards,
David

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Post by 7432 » Thu Apr 09, 2009 10:56 am

you could roll out to 2011 or 12 and give your system a couple more points to the upside, june 2012 trades 96.905.
during the crazy times a few months ago when nobody could guess how low rates would go, the cme listed strikes above 100, I think all the way to 105. so somebody somewhere doesn't think there is a cap at 100.

bottom line is that its tough to test unless you can get data from the 1940's when 10yrs made the historic low of 1.82%. maybe short term rates were negative at that point.
and maybe in 6-12 months the fed will be so desperate to get people to spend, short term rates will be -1%.

M20J
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Post by M20J » Sat Apr 11, 2009 8:33 am

Many thanks to everyone for their thoughts.

Regards,
David

jas-105
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Post by jas-105 » Mon Apr 13, 2009 2:54 am

Libor can go negative so the upside is not theoretically limited to 100, although one doubts 100+ prices would be stable for any length of time.

Also, there is backwardation in the eurodollars, so you would make money on longs every time you rolled with a static libor rate, quite a likely scenario for the time being.

I hope this helps !

Demon

Post by Demon » Mon Apr 13, 2009 3:57 pm

Jas makes my point exactly, real interest rates could negative.

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