Friday, November 21, 2008

Stock traders from Mars, Bond traders from Venus

(Relayed by Citizen Jensen to explain negative long swaps... my Ovaltine decoder is having trouble translating, perhaps you will have more luck at it... Back in college 'contraction of my bermuda book' meant something entirely different- AM)

We have seen heavy receiving from insurance companies and real money who are faced with significantly lower assets and have seen the duration of their CMBS positions shorten dramatically as dollar prices have fallen over 40% in two weeks. We know that pension funds are underfunded and need long dated assets and that structured desks need to receiving the long end both as the curve inverts and the yen appreciates. option desks are short significant amount of low strike receivers on 20y and 30y tails from the pension fund risk reversal trade (starting in 2003 when pension funds first started to become underfunded and the longer dated forwards were around 6% they went on huge programs in which they gave up their upside- sold 7% payers (+100 bp) since 7% was greater then their liabilities to buy 5% (-100 bp) receivers to lever up in a low rate enviornment). Since that time they have consistantly been rolling out their low strikes, leaving dealers short gamma and vega on the long end. given that the rates came into the week already at historic lows they have been reluctant to cover their shorts as those rates moved 150 bp, resulting in a capitulation yesterday. In my commentary on Monday i stated all of the reasons why the market was too cheap and that a few different ways to get long the belly of the curve. While those reasons are all still valid, at this level in rates it just doesnt make sense for insurance companies or pension funds to receive the market as their liabilities are higher then 3% and they would just be locking in losses. It seems to many are now in the market cant sell off camp which makes us very succeptable to a big flush out on any news by the fed/treasury/gov’t….. and oh i should add that gamma was up another 8 bp vol (1m10y is now 212 bp vol) and vega another 4 bp vol as dealers and agencies are short from the contraction of their bermuda books.

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