wmeubank@ocp.kcmo.com
THE SPREAD TRADER
Prepared by
Prudential Securities, Inc.
Spread Trades Of The Week
DECEMBER T-BONDS/T-NOTES
The T- bond/T-note spread often acts as a proxy for outright prices because the differing maturities in the instruments cause the 30- year T-bond to be more sensitive to interest rate changes than the 10-year T-note. Indeed, T-bonds rally faster than T-notes when yields drop and prices rise; bonds fall faster than notes when yields rise and prices drop.
T-bond prices have been moving generally higher from the mid-August to mid-September lows. Over the same time, the spread has expanded in favor of T-bonds, with the T-bond premium rising from less than four points over T-notes to a recent high of about 5.75 points. The long-term chart illustrates that T-bond premiums in excess of six points usually are not sustainable. Because we believe that the bond market is likely to remain within its recent trading range, we recommend buying T-notes and selling T-bonds at a 6-point T-bond premium. We also recommend reversing the trade (selling T-notes and buying T- bonds) when the T-bond premium shrinks to 3.75 points. In either trade, we are looking for a 2-point move from entry and are willing to risk 0.75 points.
MARCH/MAY PORK BELLIES
Pork belly spreads are governed by carrying charges because the product is a storable commodity. Therefore, despite the traditional volatility in outright prices, spreads within the same “crop” have always stayed within certain historical parameters. At current prices and interest rates, a nearby contract should not fall more than about 75 points per month below a more deferred delivery. With March already at a discount to May, last Friday's quarterly Pig Crop report (released after the market close) should not adversely affect this spread. Indeed, a bullish report should cause the spread to gain.
We recommend buying March and selling May pork bellies at 120 points May premium, adding on to the position to the point of fully carry at 150 points. Our objective is even money. We will risk 50 points from entry on each position.
Open Positions
LONG MARCH/SHORT MAY WHEAT
At 3 cents and 6 cents May premium with an objective of 10 cents May discount, risking to 12 cents premium May.
LONG DECEMBER/SHORT FEBRUARY CATTLE
At 160 points February premium, with an objective of 100 points February discount, risking to 360 points February premium.
LONG 2 OCTOBER S&P 680 PUTS/
SHORT 2 OCTOBER S&P 750 PUTS
At 25 points credit, collected twice, with an objective of zero, holding the position as long as the market is above 750.
LONG AUGUST 1998/
SHORT SEPTEMBER 1998 SOYBEAN MEAL
At 30 points September premium, with an objective of 500 points September discount, risking to 300 points September premium.
September 29, 1997Don Selkin
Prudential Securities, Inc.
One New York Plaza, New York, New York
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