First Ever Post - Money Markets Question

Hi guys,

this is my first ever post on this forum & I have a money market question for you.

I have never put on a trade, at the moment I am just trying to understand a little more about STIR's and see if I can get a feel for the market.

One thing I have noted is the relative steepness of short-sterling H0-H1 relative to Euribors and ED. Is there value in a H0-H1 flattener?

For anyone who trades these markets, how could I look at the risk-adjusted returns of SS relative to Euribor and ED? I am assuming that the spread can be composed into (1) expected policy changes and (2) risk premium. I am assuming SS is a higher beta product but how can I look at the risk-adj return? Would I look at historical vol. on SS options or a 1y GBP swaption vol?

Really appreciate your thoughts / help!

That's a very good question and an interesting dilemma and well STIRred if you don't mind me saying so...I wonder if someone sporting ridiculous glasses (preventing his immigration into Thailand) who also goes under the forum name "Arabian Nights" would like to field this particular query...

First of all, very nice question... I have a view on this, so I will not wait until Cap'n Arab returns from another one of his drunken orgies (just envious, is all).

I liked this trade 12 bps ago and we actually discussed it in the STIR chatroom on the very first day of the New Year. I suggested doing it either the U10/H11/U11 fly or the U10/H11 spread of spreads vs Euribor (short stg flattener vs Euribor steepener). It's all the same trade and, funnily enough, so is gilt-bund.

You can look at the risk-adjusted returns on the spread trade by using historical vols, but it's going to be very very difficult to do it with implieds, regardless of whether one uses swaption or sht stg vols.

As to the decomposition of the spread, one of the most common ways of doing it is to look at the MPC-dated SONIAs to get a picture of what's truly implied for policy changes. However, there are a few issues with that: 1) dates mismatches introduce inaccuracies; 2) exact meeting-dated rates are not available as far out as the reds, so you'll have to compute them from your SONIA curve, which can create issues; 3) most importantly, SONIA rates also contain risk premium, albeit it's a lot easier to deal with, esp for meetings that aren't too far away. So all that remains, really, for whites/reds is art, rather than science.

Drunk orgies? I given up drinking for January, every six seconds I'm thinking about London Pride

Martin seems to have answered everything technical so re views on trade, I like the "story" behind it so long as it's versus ED... V Bor I guess your issue is that historically their rates have always been low and while it's reasonable to expect this to change as UK continues to disintegrate the value doesn't quite seem to be there yet imo.

As an aside, you might like this: http://www.bloomberg.com/apps/news?pid=20601068&sid=amoWnHwWMrbE

thanks guys, extremely useful points indeed.