Interest rate swap

[jm99]

So I take it you are worried about hyperinflation and high rates??

aye

 

[MrGecko]

Yes, MrG, LIFFE would like you to believe there's gilt options. However, if you look, open interest on them is and had always been 0. For all effects and purposes, they might as well not exist.

As to using gilts to hedge the base rate, there's all sorts of extra risks you're getting yourself into (asset swap being the biggest one). It's possible, but I would stick to LIBOR/base, personally, as I perceive it as a less dangerous and less complicated position.

Sure, I had a sneaky peak at the OI just after I posted the link... you would have thought there would be a market in these things, wouldn't you..??

 

[Martinghoul]

Sure, I had a sneaky peak at the OI just after I posted the link... you would have thought there would be a market in these things, wouldn't you..??

Shall we do some mkt making in gilt options, MrG? In seriousness, not sure why there's not one for the gilt. It may be that the mkt is not good/deep enough to be able to hedge properly.

 

[gooseman]

been tried a thousand times. not enough liquidity in options for market makers or end users.

 

[gooseman]

there's only interest now thanks to QE....i'd imagine thre's good money now but the month that liquidity dies the market makers will get mashed. Your vega would so volatile that trading limits would be small.

"where's the 120.50/121 call spread?"
"I'm 18/22"
"22 for 1000"
"ok, sell you 50"
"thanks for your help"

 

[Martinghoul]

So price this into bid/offer then... If the demand is there, the mkt will grin and bear it. Question is whether there's demand. Looks like there's just not enough leveraged money playing with the gilt and the real money doesn't need this stuff, so I guess it's not viable.

 

[gooseman]

what do you mean price it bid/offer?

i have no doubt that now there is demand enough but it'll soon die. like the other attempts to make the gilt options market work.

just not a big enough market and as you say not enough players.

saying that i'd like to be long some longer dated puts for sure

 

[Martinghoul]

I mean price your hedging costs and your PNL volatility into the bid/offer you charge the end user, so you still make a decent margin. Obviously this would only work if there's actual demand for the product. That's something that only LIFFE/GEMMs might have a decent handle on...

 

[gooseman]

yeah bit then if you dop that you're going to have to offer something like a 5/6 tick bid offer spread. so may as well hit UST's or Bunds where you get 2 ticks max.

if someone asked me to deal on a 6 tick spread in what is supposed to be a mainstream wholesale exchnage traded market I'd laugh at them.

again you hit the nail on the head with demand. Liquidity has to be there for the liquidity providers to at least have the option of getting out before they get run over with the vol change....

 

[jm99]

You might be able to take the caplet route through a SB'er too... or even use options on Gilts which might better reflect your underlying rate (as a function of the base) - but you are getting into proper financial engineering here...
NB: A cap is just a series of caplets, options on interest rates. Also, personally I prefer taking the Gilt route if your floating rate is a function of Base rather than Sterling LIBOR - the reason is that if you are paying base but recieving LIBOR, you are exposing yourself to term-Sterling-TED risk (i.e. the difference in credit quality between AAA contributing banks and the UK G'ment... which is sheer lunacy... unless you are long, which I think you might be here???)

yeah, was looking at options on ed cme last week as a concept to provide some protection (aware of the exchange rate risk and just cos i can trade them via tradestation, no stirs) ......pretty much exhausted the idea of a perfect swap, so happy with the libor risk.

.....which leads to the next question re caplets..... any ideas on specific methods ??

 

[MrGecko]

too late for a sensible answer (hic!), I will just highlight that eliotsagor has his position on the swap rate, which isn't dissimilar to LIBOR anyhow.

p.s. for f*cks sake, whatever currency your loan is in, hedge that risk. Don;t c0ck about with eurodollar.