Software Vault: The Gold Collection/Software Vault - The Gold Collection (American Databankers) (1993).ISO/cdr11/tedspred.zip/TED.TXT

Text File | 1993-06-19 | 10KB | 202 lines

I just read a copy of the SuperInvestor File.  The first file talks
about playing TED spreads.  For those of you that don't know what a
TED spread is, it is a method of manipulating options in which you go
long on 3 month T-bills and short on 3 month Eurodollars. Since
Eurodollars usually trade a 10% to 20% premium over T-bills and
usually have more volatility over T-bills, you profit by closing the
position when there is a wide difference between the two.

1) Has anybody out there tried this investment technique?
2) Does it work?
3) What kind of return have you made over the past years?
4) Who do you trade with?
5) What is the commission on a trade?
6) What is the downside of this technique?

I would greatly appreciate your input into this as I am very
interested in it.


RA>I just read a copy of the SuperInvestor File.  The first file talks

The Superinvestor files are a good introduction to spread trading but,
as with most introductions, they oversimplify.

You might find the following interesting on the TED.  It's from a
Bloomberg Quotation system article.  It's a bit long for netmail but I
think it's worth it.  I'll answer your other questions in a separate
post.

Quote

War and Peace and the TED Spread

      Lured by stories of fabulous profits with defined and limited
risk, many futures neophytes take their first trading steps playing
the Treasury Bill/Eurodollar, or TED spread.  During the Continental
Illinois Bank & Trust failure in the second quarter of 1984, the
spread widened from 100 to 200 points and TED players briefly showed
returns of more than 100 percent.  The three-month period in 1987
after the stock market crash saw similar returns. And anyone buying
the spread at 93 basis points on December 10,1990, and selling it one
month later on January 12, 1991, would have shown a profit of $1,650,
less commissions.  All this for an initial investment of between $300
to $500 for a single contract.

      Essentially, playing the spread is betting that the difference
between the prices of futures contracts on Eurodollar deposits and
those on U.S. Treasury bills will increase.  This spread exists
because of the different risks involved in the two investments. T-
Bills are backed by the full faith and credit of the U.S. government
(and its taxing power)  and so are considered the safest investment in
the world and the standard by which others are judged for both risk
and return.   Because of this and their large market, they are
extremely liquid.  Eurodollar deposits, on the other hand, are similar
to certificate of deposits offered by American banks. They are not
backed by the U.S. government or by its banks, nor is their market,
though it has grown considerably, considered as liquid as that for T-
Bills.  EDs are thus seen as riskier and so pay higher interest rates
than the U.S. instruments.

      But why does the spread fluctuate?  One factor can be bad news.
Whenever there is a major political or military crisis in the world or
instability in the financial system, people lose confidence in the
safety of their investments.  They then flock toward the security of
the zero-default- risk U.S. Treasuries.  Demand goes up, and
consequently, so does price. Simultaneously, those investors who have
dollar deposits in institutions of the unstable financial world remove
them.  Demand for EDs thus goes down, along with their price. Even if
ED deposits are not withdrawn, the instruments cannot keep pace with
the more secure T-Bills.

      So since the typical TED spread contract involves going short
90-day ED futures contracts and long three-month T-Bills, the investor
profits from bad news.

      You don't have to be a doomsayer to gain, though.  When interest
rates rise, those on EDs usually go up 10 to 20 percent more than
those on T-Bills, again reflecting the different risks of the two
investment vehicles.  And the fall in price consequent on the interest
rate rise is steeper for EDs that for T-Bills.  So in this situation,
you lose some money on the T-Bill side but more than make up for in on
the ED side.

      You can't always win, of course.  If you profit when the spread
widens, you lose when it narrows.  Narrowing occurs when interest
rates fall (unless T-Bill rates decline faster than ED rates) and the
recovery after a crisis. For example, before January 16, 1991, the
first day of the Persian Gulf conflict, anxious investors pushed the
spread up to 159.  On January 17, it dropped 28 points, or  $700 per
contract.  Apparently, the allies success calmer the markets.

      The situation today (January 1993) is considerably less
tumultuous. Let's say the spread is 40 points.  At $25 per point, if
the spread where to drop to zero, the most you could lose would be
$1,000.  But this assumes that the risks of T-Bills and EDs become
equal, which is unlikely:  The spread is probably not going to narrow
to less than 25 points.  So with everything calm in the financial
markets and interest rates low, the TED player has unlimited upside
potential with a likely risk of only a few hundred dollars.

      Right now (January 1993) the spread is at historically low
levels.  This doesn't necessarily mean that it's time to buy, however.
Some advisers believe that earlier assumptions about the TED may no
longer be valid.  Just as fold in no longer considered the safe haven
in used to be, so the TED may have fallen from grace as an indicator
of financial confidence.

      During the savings and loan fiasco, for example, when the very
foundations of the U.S. banking system seemed to be disintegrating,
the spread did not even come close to the levels reached in the early
1980s.  That was because investors had already seen the federal
government's rescue of Continental Bank.  If the government is going
to step in whenever there's a financial crisis, where's the risk? Just
look at the bailout of the Bank of New England and others. Failing
banks are almost nationalized before they are allowed to expire.  Add
to this the fact that the major international banks have higher
reserve requirements than in the past, and the pallbearers for TED
would seem to have good reason to write its epitaph.

      In addition, people's perceptions of the potential of political
catastrophe in Europe has changed dramatically.  East Germany's fall
and subsequent merger with its Western counterpart, the collapse of
the Warsaw Pact and the disintegration of the unified Soviet state
have left investors unmoved by events, such as the disintegration of
Yugoslavia, that would have been shocking years ago.  And the markets'
reaction to the crisis has become accordingly less extreme.

      Still, there are other advisers who feel that it is too early to
write off the TED.  True, the spread is narrow; it will remain narrow
as long as we are in recession.  With business borrowing low, demand
for Eurodollars in the international market place has fallen. And as
the U.S. government continues to feed its huge debt, the supply of T-
Bills relative to EDs keeps growing. Consequently, while supply and
demand have pushed rates on both instruments to their lowest levels
since 1972, the ED's rate has actually dropped in relation to the T-
Bill's, and the spread has therefore narrowed. Once rates begin to
climb, the spread will likely widen again.

      Moreover, a wider spread means larger fluctuations.  If today's
spread is 40 points and it moves 10 percent in either direction, that
represents only $100.  If, however, the spread were to resume previous
levels of more than 100 points, a move of 10 percent would be worth
several hundred dollars per contract.

      When all is said and done, if the TED spread is not dead, it is
certainly comatose.

A Basis for TED

      A basis point in terms of Eurodollar deposits and Treasury bill
futures is 1/100 of a percent (0.0001), making a maximum of 10,000
points in any once contract.  Since the face value of an ED or T-Bill
futures contract is $1 million, the value of a point is $100
($1,000,000 / 10,000).  However, the interest rate of EDs and T-Bills
(and the price of their futures contracts) is stated in terms of an
annual yield.  Since the T-Bills and EDs of the TED actually mature in
90 days - 1/4 of a year - a $100 point representing a full year of
value is adjusted to $25 per point representing 90 days.

Unquote


  >3) What kind of return have you made over the past years?

100% but then I've only traded it once - the Gulf War.  I wouldn't
trade it according to the Superinvestor right now.  In a low interest
rate environment, there isn't enough risk to make in fluctuate.  I
only trade it when the international scene is extremely disrupted as
it was at the beginning of the Gulf War.

  >4) Who do you trade with?

There are a number of good discount brokers:  Ira Epstein, Lind-
Waldock.   Pick up a copy of Futures magazine for names, numbers, and
addresses.

  >5) What is the commission on a trade?

Varies from broker to broker.

  >6) What is the downside of this technique?

100% plus.  All the money in your account plus more if the market
moves limit down against you on both sides of the spread and the
equity in your account can't cover the margin call.  Is is likely to
happen in the TED spread?  No but you can still lose 30-40% on the
first trade.  This is where Superinvestor is very misleading. FUTURES
INCLUDING SPREADS ARE VERY VERY RISKY!!!!!!!!!!!!!!!!!


This information, as well as that in many/most of the remaining files,
is available at a fraction of the cost in various newsletters and
financial magazines.  The information is typically available under the
exact same name, typically for free in the public library magazine
stacks.  The TED spread has been documented for about 15 years at
least (I remember because I had just changed jobs) in either Money or
something similar, as well as Personal Finance newsletter, which is
available for $79 for a 2 year subscription.

Regarding the TED spread, no experience.  Suggestion regarding the
SuperInvestor files is to save your money and use the library.