Weekly Market Summary - 1.27.06

Weekly Market Summary
C. Johnson – New York
cedrickj@gmail.com
01-27-2007, 4:02PM EST

It has been an interesting week across all world markets that enables me to write about in the first month of 2007. First, let’s start out with the Foreign Exchange markets, as I’ve seen an interesting trend with the volatilities across the major currency pairs:

EURUSD Vols (1/26/07 close) (Source: Bloomberg)

The EUR/USD 1M straddle volatility has come off of the highs that we’ve witnessed in the latter part of 2006, from the 7.50% level to currently 6.0250%. The vols are approaching the bottom of an uptrend range here, so any breakout of volatility on the EUR/USD straddle (below 6.0 and above 6.20%) will set the tone for some longer term FX options plays that I would consider. I believe that with the EUR/USD spot stalling out at the 1.30 level (remember, based on the Iron Fly trade, I am anticipating that the spot will fall around 1.3100 on Feb 2 for the 10AM expiry) any significant move could send volatility higher. I currently am maintaining a bullish bias on EUR vols going forward. The only caveat to a higher move in the EURUSD vols would be resistance at the 6.70% level, so assuming that 6.70% proves to be tough to break through, I’d be looking to lock in EUR vols from 6.50-6.65%, which is not bad, considering the fact that I would risk only about 10bps from the entry, for around a 40bp gain in vol.

EUR/USD 24H X-Rate Chart (Source: Bloomberg)

Next, I’d like to focus on the EUR/JPY, which has seen us test the highs of the volatility range at 7.76%. Recently as of this week, with news out from the BoJ suggesting that Japan (and other Asian accounts) were sellers of US Treasuries, and taking that money and using it for currency transactions for their respective nations, we have seen a spectacular jump in volatilities, most notably running from around 6.34% to levels not seen since September 2006. Due to the severe move of both the spot, and the volatilities in the week, I am going to establish a bearish view on this pair, and I am looking to be a seller of volatility in the coming week, with a target in the 6.60-6.50% range. Stops will be around the 7.50% range. In this particular scenario, I am risking about 20bp, for a 50-60bp gain. Currently, the vols for this pair are trading at around 7.2750%.
EURJPY 1M Straddle Volatility (Source: Bloomberg)

EURJPY Spot Historical Volatility (Source: Bloomberg)

EUR JPY 24H Price Chart (Source: Bloomberg)

US Treasuries
This week has been an extremely “interesting” week in the US Treasuries. We’ve seen a lot of selling coming into the marketplace, and the rumor on the desk is that the Asian accounts are flooding the desks with selling, and they are using the proceeds for currency intervention. And, with that, we’ve seen quite the action across the yield curve, most notably steepeners being put on with all the selling. Here’s a breakdown of the common treasury spreads and how they have played out on the week:

Spread (Sell/Buy) Current Spread Spread Change (01.26.07 close)
3M/2Y -16.0 +0.96
2Y/5Y -10.7 +1.07
10Y/2Y +9.9 +0.19
10Y/30Y +10.0 +0.85

Yields have risen on this selling, and according to strategists at RBS Greenwich Capital, the yields have reached their targets, but they have maintained a bearish bias. The 10Y cash reached the 4.87%, while the 30Y inched towards 4.97%. Many people (including myself) predicted 30 and 10Y yields would approach the 5.0% level, and that level is still key going into next week. Note: we do have Non-Farm Payrolls due up next Friday, and that could prove to be something that will keep many of us on edge as we are near such critical levels in the long end of the spectrum.


US 10Y OTR Yield (Source: Bloomberg)

US 30Y OTR Yield (Source: Bloomberg)

UK 10Y Bond Yield (Source: Bloomberg)

I am disappointed in dropping my faith in the 2/5 spread, but given the test of the -10 level as we headed towards curve steepening, I’m glad I did take the profits on that one when I did. The dip back down into the -14 region would have been extremely hard to swallow, given my stance in the Treasury markets now. First, if you recall, we were talking about a Fed rate cut sometime in the year. Everyone on the desk was talking about it, and quite frankly, my views are more short term now than they have been in a number of years. I am maintaining the stance to live for the moment, and if that means leaving gains on the table as we get in and out of positions, I am perfectly fine with that, as being nimble during these times allows me to get some sleep at night. There’s too much global risk out there that can throw all of this research, thinking, strategizing off. Iran comes to mind as the #1 catalyst for any issues that could send everyone running for a flight to safety.

One thing that does perplex me is the extremely narrow spreads in the entire Fixed Income complex. Spreads against several things, such as Mortgages, Credit Defaults, etc are pretty narrow as compared to in the past. But, as I see it, the global risk should have those spreads against the Treasuries a bit wider.

US Spread Summary (US Components) (Source: Bloomberg)


It will be an interesting week going forward, and I am looking for some opportunistic plays in the short term. Currently, I have a butterfly on in the S&P 500, and given the strength of the resistance in the 1440-1450 level, I don’t anticipate too much of a move this week out of the 1415-1430 range. I believe that we will be stuck in that range for at least a couple weeks. This view is held only short term, and I will be looking to dump the options at a profit early this week, and move on to gathering research for perhaps another dispersion trade, as VIX continues to be a bit constrained at these market levels (around 10).

Silvia Goodness

Nakul likes her.......

Mike C's 10yr vol settles/comments - Jan 9, 2007

Reprinted with permission from Mike Curto:

Volatility again lower as we viturally did nothing to carve out a new range today but still traded fairly heavy volume with nearly 700,000 contracts in the 10yr futures. Deal flows have been pretty mixed with enough dealers willing to sell upticks ahead of new supply as the old rate-locks are unwound and not enough fund buyers to really push it out of whack on the upside. Greenwich mentioned that the market continues to get flatter and that is evident with the last Committment of Traders report showing only 60,000 net longs from Euro$'s out to 30yr futures. Fairly big put 1x2 buyer in 10yr options, maybe the Vega Asset Management crew on the March 106-107 put spread 1x2 for 7 ticks 10,000 x 20,000 on the initial low of the day around 107-24. Last time they were right on an options play was well over six months ago. We pretty much stand idle and see if there is any downside left in stocks (specifically emerging market stocks) and any strange type of flight to quality as a result . . . . until Friday which is our first major piece of data this week with retail sales.

108-12.5 to 108-10.5 old volume bulge
108-04 Non-farm payrolls breakdown area
107-25.5 to 107-20.5 growing recent volume bulge
107-15.5 mortgages sold long puts



Realtime bond commentary live from the CBOT Treasury Pit complex at http://www.tradersaudio.com/cbot30.htm

CDS Analysis

Some interesting charts with CDS action going on in the big carmaker section, I am currently analysing them now, will re-edit and provide more insight on these later, but it's hard to juggle 10 things at once at 8PM and try to get out of the office!

Ford - Credit Default Measurements

GM - CDS Measurements

Interesting downtrends isn't it? Seems that the worries are subsiding with the higher stock prices that both of these have seen. Check out MarketOperator's analysis on F/GM at his blog from my links section as well.

Charts from http://www.creditgrades.com

Mike C's 10yr vol settles/comments - Jan 8, 2007

Reprinted with permission from Mike Curto:

Volatility is back near recents lows as it approaches around 3.75% in the very front month February 10yr straddle. We still have inflation data coming next week but apparently the market isn't worried about anything besides right on the screws with expectations. Read an article on bloomberg.com that mentioned fairly large sums of money have been flowing out of TIPS (Treasury inflation-protected securities) funds. This shows real money is putting their money where their mouth is and really not worried about inflation at all. There is also a 10yr TIPS auction this week and based upon the aforementioned would not expect it to go well at all, although their has been pretty solid indirect demand at the last few. Same funds that were getting long on Friday seemed to be back in again today but most likely rate-lock sellers for this week's almost 20 billion in corporate supply capping us off. Lots of volume for a quiet Monday. If most of these deals price middle of the week and the funds are still buyers then this could get messy on the upside as the rate-lockers unwind their hedges. Major risk to the downside would be the supply not really hitting the Street very well but when was the last time the market didn't easily take down 20 billion in supply like it was today's lunch ???????
10yr FUTURES LEVELS

108-12.5 to 108-10.5 Old volume bulge
108-04 Non-farm payrolls breakdown level (recent shorts maybe stops just above)
107-23.5 down to 107-20.5 HUGE volume bulge from last week and dip buyer level
107-11.5 to 107-05 recent lows and old volume bulge

Realtime bond commentary live from the CBOT Treasury Pit complex at http://www.tradersaudio.com/cbot30.htm

Weekly Thoughts

It's been an interesting week, with headfakes on my steepeners, and the 2/5/10 b'fly being put on hold for now. Some of the players in the markets have been moving out of the way, especially those call sellers up in the TY around 108/109 calls, in perhaps a view that the depressed price levels could be only temporary. The 2/5 curve, as expected, hit some heavy resistance at the -10 bps level, and I began to unload near -11. I'm still inclined that the inversion trends on the short end of the curve could straighten out, and we can be on a path towards a steepening curve, but the old saying of never look a gift horse in the mouth comes to mind at this point. I can be agile enough to get out of the way, and put the full force trade on once -10 is breached, and the market stays above that level.

The euro iron play taking a bit of a beating, with the spot settling around 1.3000. Our month end target for 1.3050-1.3130 still stands, and I think that the small risk that we have a major move outside of those areas will be quite small, given all of the economic news that we've seen coming out of the US this week.

Now, for something off topic, something that's been disturbing me for quite some time, and that is how corporations work. If you put in your best, depsite your faults, the faults still stand in the way. And, you can have excellent marks for work quality, but one area can be a big factor - a factor so much that folks want to screw you over at the end of the year. Well, all I can do is take the lessons learned, be glad that I didn't get sucked into the trap and ambushed, and move on. I can move forward, take the experiences learned, and not repeat the same mistakes. And, I plan on doing just that. Moving on, just like you're supposed to do when the markets themselves, despite your best work, your high marks, screw you over.

Oh, and a highly recommended book for folks who have asked me about the Treasury Bond Basis:

http://www.amazon.com/Treasury-Mcgraw-Hill-Library-Investment-Finance/dp/0071456104

-CBK

Morning Trade Update

Well, the FOMC did it's ditty yesterday, and the equity markets took a small beating, as I am sure you're aware now. The statements made by the FOMC were somewhat on par with what I was expecting, and the reaction in the bond market at first was kinda muted, but now I am seeing some clear direction here with respect to the spread trade. Currently, the 2/5 has moved into my favor, and is trading around -10.3, reaching a high around -9.9 earlier this morning. As expected, there appears to be heavy resistance at the -10bp level, but the factors that caused me to put the trade on have not changed, and as I stated before, if we can break -10, and sustain that as a support, I will be looking to add to the position, with a target around -7bps. The 10/5 spread is interesting here as well, because it has shown signs of steepening as well, currently up 0.5 to +1.0bps, off the highs, but then again, we're chopping around a bit here. 30/10 spread is currently +0.2 to +10.7, and that spread has recovered nicely off the lows seen in late 2006.

The 2/5/10 butterfly is looking even more compelling to me as well..

Note out of Greenwich, they have a inversion bias on the 2/10 which could play into my decision to cut the existing trade short, but I do see mixed signals with respect to that and the 2/5/10 b'fly.

2Y clearly leading the way this morning, 11.8 billion traded on the ICAP cash now, followed by 5's at 8.5bln. Dollar flows largely positive on the 2Y, +1.702bln vs -150mln for the 5Y.

10Y OTR's trading at 4.642%, with the old currents trading at 4.651 for a +0.9 bps difference in yield. The only thing trading at a lower yield than the currents is the 4 1/8 maturing in May 2015. It's trading at 4.641% -0.1bps.

Paper Trade Idea

*note: this is a modelled trade, and the author does not have a active position in this trade (EUR/USD Iron Fly)

I was able to sit down last night and do some OTC options modelling, and a good friend was asking me about Iron flys, so I decided to try to model one out. Basically, trying to collect premium by selling a near ATM straddle, and buying a slightly otm/itm strangle on the EUR/USD options in the OTC market.

Leg 1

Side: Buy

Ccy: EUR/USD

Class: European

Maturity: 1 Month

Expiry: Tue 6 Feb 07

Expiry Days: 33

Delivery: Thurs 8 Feb 07

Strategy: euroPut

Strike: 1.3000

FWDW: 0.9%otm

Amt: 2.5MM EUR

Ratio: 1

Spot: 1.3095

Forward: 1.3114

Swap: +19.0

Depo: 3.61

Volatility: 6.860

Model: Analytic

VM Source: Fenics Math

Payment Conv Rate: 7637

Premium: -11391 EUR

Leg 2
Side: Sell
Ccy: EUR/USD
Class: European
Maturity: 1 Month
Expiry: Tue 6 Feb 07
Expiry Days: 33
Delivery: Thurs 8 Feb 07

Strategy: euroPut
Strike: 1.31
FWDW: 0.1%otm
Amt: 2.5MM EUR
Ratio: 1

Spot: 1.3095
Forward: 1.3114
Swap: +19.0
Depo: 3.61
Volatility: 6.930

Model: Analytic
VM Source: Fenics Math
Payment Conv Rate: 7637

Premium: +19407 EUR

Leg 3
Side: Sell
Ccy: EUR/USD
Class: European
Maturity: 1 Month
Expiry: Tue 6 Feb 07
Expiry Days: 33
Delivery: Thurs 8 Feb 07

Strategy: euroCall
Strike: 1.3100
FWDW: 0.1%itm
Amt: 2.5MM EUR
Ratio: 1

Spot: 1.3095
Forward: 1.3114
Swap: +19.0
Depo: 3.61
Volatility: 6.930
Model: Analytic
VM Source: Fenics Math
Payment Conv Rate: 7637

Premium: +22069 EUR

Leg 4
Side: Buy
Ccy: EUR/USD
Class: European
Maturity: 1 Month
Expiry: Tue 6 Feb 07
Expiry Days: 33
Delivery: Thurs 8 Feb 07

Strategy: euroPut
Strike: 1.3200
FWDW: 0.7%otm
Amt: 2.5MM EUR
Ratio: 1

Spot: 1.3095
Forward: 1.3114
Swap: +19.0
Depo: 3.61
Volatility: 7.050
Model: Analytic
VM Source: Fenics Math
Payment Conv Rate: 7637

Premium: -13795 EUR

Strategy Totals:

Premium: +16110 EUR

Price: 84 1/2 EUR

Delta: 0

Vol Adj Delta: +1.0%

Gamma: -2.60%

Vega: -2.02

Time Decay: +0.19

Phi: -0.02

The Phi is very negligible here, only $-4USD for the strategy. Now, we're pinning for 1.310 at the Feb expiry (see chart below):

Good day so far, going to be watching a lot of stuff

-cbk

New Year Comments and Observations

Well, now we have assembled all the players in the bond market on our first full day of trading here in the US, and so far, things have been going along, as expected. Here's some highlights I wanted to share with you as we proceed through the trading day, and highlight some of the things that are shaping my trading outlook and views going forward in 2007.

First, an update on the 2/5 spread which I talked a bit about last night. We're currently trading at -11.1, and it has reached a level around -10.4 before falling back down to the current levels. At the current level, we have steepened about 1.4 bps since yesterday, and as I said before, the -10 level should prove to be the point where there will be the most resistance (for a while in 2006, it was a key support that many viewed as if breached, we would reach the lows of -19.8). I am watching this for confirmation, and once I see that we can successfully trade through that -10 level, I will be adding on to the trade, in anticipation of steepening to around -7 bps level.

I was reading David Ader and Ian Lyngen's 2007 outlook from RBS Greenwich Capital, and while they talk about probabilities of what the Fed will do in 07, I am refraining from comment. I got lucky with the first IR pause (for which I even made a song struck to the lyrics of Strike A Pose[Pause]), so I don't want my luck to run out on that front so early in 2007 :)
They are suggesting that we could see a Fed ease in rates, given the right economic conditions in May or June (earliest timeframe), which would begin to move the curve from inversion to a steepening mode. I've shared that steepening mode view for quite some time, given that especially in the 2/5 that we could not break past that -20 inversion, and the 5/10 has been reluctant to go below -2 bps inversion (the low was -1.3, average is 5.5).

What are some risks to my bias and the current trade?

1. FOMC FedSpeak - as the economy may begin to slow down, and inflation fears begin to subside, we could see FS begin to take a less hawkish tone, to one that is more rate-neutral. RBS doesn't see this happening until around Q2, once the Fed has seen enough data to make a decision. I happen to see that happening late Q1, as I believe that the data is already present (see Housing comments below)
2. Q1 Duration/convexity buyers coming in with force
3. Percieved view that Q1 weakness is a buying opportunity to the longer term - My fear is that people will mass-overreact when prices begin to move lower, and distort the curve dynamics by buying because they are relatively "cheap" and have no regard for the curve shape (that's already happened now, though)
4. Asia Risk: Could go both ways on this one.. China has a heck of a lot of reserves sloshing around in their system, so they could come in and buy more Treasuries, or they could diversify into other economies. The diversification risk is, in my opinion small, given that the US 10 year is currently producing just about the best yield out there.

Some interesting facts cited by the RBS outlook include:

• China has 1 trillion in FX reserves, and that is growing at a rate of 200 bllion/year. Given that, there's 240 billion and more with maturing debt coming in (4% interest on the 200b included), combined with a conservative 50% US allocation, that's about 10 billion/month coming into US Treasuries.
• Foreign entities own about 55% of US Treasury debt - primary concern would be a extremely weaker dollar causing an 'event' which would start a unloading of UST's. I personally don't see that happening unless the euro gets into the 1.40-1.50 region.

I am additionally concerned about the housing statistics. According to the fine folks over at RBS, home and condo sales have dropped off markedly. Debt to Homeowners Equity is through the roof now. That to me spells a recipe for disaster in the housing market, and why do I say disaster? Everyone and their mother bought these homes with ARMs (Adjustable Rate Mortgages). People who could not afford these homes with traditional fixed rate products were able to leverage themselves to destruction because ARMS placed at the right time when rates were dirt cheap enabled them to jump on the leverage boat. Now, buyers are drying up, and these ARMS over the next year are going to be "reset" to the prevailing market rates as of now. RBSGC estimates that 1 trillion USD will reset over the course o f 2007, and with those resets, I expect that foreclosures will begin to spike up, perhaps to levels that would shock even the most hardened and time-tested strategist/observer.

There's so much more to analyse, but that's all the time that I have for now. Have a great day!

More Treasury Analysis

Well, I was sitting here talking with my pal over at Bondsquawk.com about the recent events that have taken place in the bond and futures markets, and I feel a bit of confirmation from our discussion. First, I'd like to talk a bit more about the 2/5 steepener trade that I have now initiated, then I'll talk about some of what the rumor mill is on the street that could definitely support this view.

First, the 2/5 is trading -12.5 under now, unchanged on the evening session on ICAP. That puts us near where we started with this trade. My initial target will be -10. The -10 level has proven time and time again in 2006 to be the key battleground area, and from what I've seen so far in the new year, as we get closer to this level, we tend to fight passing it. Thus:

If we can take out the -10 level, I believe that there will be upside to possibly -6 or -7 bps. I would then expect -10 to become support as we try to steepen out of this inverted mess we're in now. I would be looking to add to the steepener on subsequent tests of the -10 level.

Why? Well, as Mike saw in the pits last week, and I witnessed simultaneously on the cash screen, a big player in Midtown have been putting on increasingly bearish trades on the short and midcurves. As this was going on, we saw some noticeable steepening in the 2/5 spread, and at least now I know that I am on the same side as the institutional props (somewhat).

As far as another catalyst, Goldman prop has been increasingly playing a bearish option trade, primarily selling bond calls, and buying heavy near-ATM puts, and slightly OTM puts, which could indicate that we are indeed setting up for bearish price action (bullish yield action) that could cause us to at least steepen in the short to mid portion of the curve.

Take a look at this as well, another Midtown player has been playing with the 2/5/10 b'fly trade, and looks to me like we've broken through a downtrend resistance that has been in place for much of 2006 on this particular trade. I easily see us hitting -10, and perhaps even -5 on this trade, and I am tempted to (in addition to the 2/5) put on a butterfly steepener at these levels as well.

Next, I'll put up a volatility chart for the options behind this trade:

Basically, someone is playing a delta neutral play on this, anticipating higher vols for the March+ expiry. Combine that with bearish trades that we've seen, and it looks like players are positioning themselves for a downward trend here in the markets, and with that, we hope that STEEPENING comes to mind.

So, for now, here's what on the plate:

Long steepener on 2/5

Contemplating a 2/5/10 butterfly steepener at these levels as well. I will have to see how the markets react once we have fully stocked trading desks tomorrow, and a handful of numbers (ADP, Non Farms)..

Also, up on the radar for early spring is Japan's new fiscal year. As some of my longtime readers may remember, this is another highly anticipated event, especially in the cash markets. Will Japan [and the rest of Asia and the petrodollars in the UK for that matter] climb on board in 2007 and continue posting strong showings in our treasury auctions? Only time will tell.

Sabre tops U.S. CDS trading in December -GFI

Interesting Story from Reuters:

LONDON, Jan 2 (Reuters) - The leveraged buyout of Sabre Holdings Corp. made credit default swaps on the company the most actively traded in the United States in December, while Telecom Italia stayed top in Europe, brokerage GFI Group said on Tuesday. Two private equity firms said on Dec. 12 they had agreed to buy U.S.-based Sabre , owner of the Travelocity reservation website, for $4.45 billion. The cost of insuring Sabre's debt against default using five-year credit default swaps shot from under 100 basis points to around 320 basis points. Automakers continued to be heavily traded in the U.S. credit derivatives market, GFI said, with Ford Motor Credit, Ford Motor Co. and General Motors Corp. ranking second, third and fourth. Gambling giant Harrah's , also being bought by private equity firms, was fifth. In Europe, telecoms continued to dominate trading, with Telecom Italia , the Netherlands' KPN and Deutsche Telekom all in the top five, joined by Russia's Gazprom in third place and British airports operator BAA in fifth. Tobacco emerged as the second-most active sector in Europe in December behind telecoms, the brokerage said. Japan Tobacco Inc. in December agreed to buy Britain's Gallaher Group Plc , leading to expectations of further consolidation in the sector. In the Asia-Pacific region, Qantas topped the list of most active swaps, GFI said, thanks to an $8.7 billion buyout offer for the airline that pushed the cost of insuring its debt against default up from 28 basis points to 200 basis points. Japan's Aiful and Takefuji were second and third, with chipmaker Elpida Memory in fourth and Japan Tobacco in fifth. In sovereigns, Turkey, Brazil, Ukraine, Colombia and Venezuela were the five most actively traded default swaps.

Short Term Bond Outlook

I know, I'm supposed to post my 2007 "Long Term View" before I start posting potential 2007 trades, but this one is hot off the presses.

[chart unavailable due to error]

From the above chart of the 2Y yields, we see that we're approaching the upper level of resistance (lower highs being made in the latter half of 06). If we can continue higher out of the 4.8 level, a test of the 5.0 level could be possible.

I will be personally monitoring the cash flow on the 2Y trade in the ICAP cash market for confirmation of sorts when we resume trading.

[chart unavailable due to error]

This chart of the 5Y paints a similar picture. Now, as you recall in the earlier chart of the 2/5 spread, I am hoping that we can retest the 4.8% level here, and then make a charge for the 5.0% level. We have taken out a trend line that was established shortly before November 2006, and if that can turn into support for the yield, I would expect rates to climb higher. That makes a case on the TECHNICALS for a steepener trade in the 2/5's, as I could see us with enough momentum easily achieving a slight +0.5 bp gain in 1Q 2007. Basically, the 5Y rate rising a LOT faster than the 2Y rate. The technical catalyst may be there, but I'm not sure that I remain convinced of a trade in the belly of the curve.

I am neutral 2/5 at this time, pending further data. No position.

For your reference, here's the 2/5 spread chart again...

[chart unavailable due to error]

2007 Bond Predictions

Well well... we finally made it through 2006, and with it, a whole hell of a mess on the bond yield curve at the same time. The trade du-jour for 2006 for me was the amazing 2/5 yr bond spread. In the early fall, we saw it inverted at a level around -9 to -10. Based on the strong demand for the 2 year bond this year, which we can speculate to the following:
1) A lot of institutions did not see value in the cash treasuries in the belly of the curve (5-10y)
2) Foreign appetite on the 2Y side was extremely strong (strong across the belly for that matter)
3) A lot of funds did not want to increase duration and other associated long term risks with accumulating belly and far-dated wings. Inflation was a primary driver of this as well.

Because of that, I chose to put on a inversion trade in the 2/5, and hold on for dear life. The stop levels were around -7 bps, but knowing my stupidity (see the 5/10 trade below), I would have let it blown through anyways. My target lined up with RBSGC's initial target of -15 bps. We surpassed that, and went to -19, almost -20. Monster inversion on the 2/5.. I was able to unwind at -17, and leave a happy man. RBSGC called for -20 to 25 bps inversion, but I could not see, at the time, factors that would cause us to get to such an "extreme" level.

So, chalk that up as a winning trade for 2006.

The next trade, was the 5/10 spread. Initially, I was expecting that spread to widen, as I thought that "inversion mania" was only limited to the short dated maturities. I was dead wrong. After placing the trade on around a +3.0 bps level, I let it ride, til I was finally stopped out right around -1bp. The trade throughout 2006 had fluctuated for the belly from +0 to +15 bps, and but putting one on around +2.5/3.0, I had hoped to capture some of the movement up to the +7-8, and see it possibly go higher. Again, my bonehead rationale was that "We Can't POSSIBLY witness a extreme inversion in the belly!".....

Loser. 2006.

Next, we venture outside the realm of bonds, and go into something new to me that I've been studying for the past year when I was at Bear Stearns. I started studying and spending extensive time in the evenings/early mornings modelling variance swaps and volatility dispersion trades. The Vol Dispersion trade I put on in November 2006 was a very short-dated trade, basically, selling 2 ATM SPX straddles (Dec expiry) and buying straddles on about 10 S&P 500 components. What was I looking for? Well, it gets complex from here. Basically, the volatility on the SPX was reaching all time lows, while vols on the components I had expected to stay the same or slightly increase.

Winner. 2006.

So, 2006 was a good year... 2 Wins, 1 Loser, and net profit. I'm looking forward to 2007, where I will be building out a new trading station in Manhattan, and re-locating the server that once ran BEAST (automated equity and now select futures contract trading system) to Lower Manhattan. I've had success with modelling out trading NYMEX Crude, so I am expecting that in the summer of 2007, we will be live with a fully automatic trading system for NYMEX crude. Once the tax season is over, and I pay the cap gains taxes, I will be re-investing about 70% of the profits into the new server system to run BEAST and the futures trading systems, as well as server colocation costs.

... You're going to have to wait a couple days for my 2007 Bond Predictions... but, I'll give you a hint... STEEPENING!! :)