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THE SPREAD TRADER
Prepared by
Prudential Securities, Inc.
Spread Trades Of The Week
DECEMBER T-BILLS/DECEMBER EURODOLLARS
This spread measures the relationship between interest rates for U.S. government short-term securities and dollars on deposit overseas. T-bills will always hold a premium because the yield on government debt must be below the rates that are paid by banks. (Higher prices for a debt instrument mean lower yields and vice-versa.) In the past, this spread has shown a T-bill premium in the vicinity of 25-50 points when interest rates are low; when there was a “crisis” of some sort, flight-to- quality buying has pushed the T-bill premium to as high as 100-200 points over Eurodollars.
Ironically, this spread has been expanding in favor of T-bills even as short-term interest rates have stayed relatively stable this year. This movement represents either concern about potentially higher rates or a flight to quality. Last week's collapse in the Hong Kong stock market brought renewed interest to “safe” U.S. debt instruments and caused the T-bill premium to climb as high as 95 points. Relative to current cash market relationships that show a spread of 75 points (about 5% for three-month U.S. T-bills and 5.75% for three- month Eurodollars), the December spread seems high. Of course, it is entirely possible that the cash market relationship will expand by December. Therefore, we will recommend selling T-bills and buying Eurodollars only if the spread continues to hold this sort of premium to the actual cash market differential as we get closer to the expiration of these contracts.
MARCH/MAY PORK BELLIES
We took profits on two long March/short May positions (from 125 and 140 points March discount) at a March discount of 60 points. These two trades were a classic example of a carrying charge spread being at its most depressed level when outright prices are at their lows and then narrowing in the nearby discount as the outright market rallies. Because this spread has shown such historical consistency to trade primarily within a range of 150 March discount to even money, we will now recommend reversing our previous tactic, by selling March and buying May if the spread were to narrow back to even. We would add on to the position at March premiums of 50 and 100 points, looking for the spread to ultimately fall back to a March discount.
Conversely, if the spread were to reach a March discount in the 140- to 150-point area once again, we will recommend buying March and selling May, looking for the narrowing to occur once again.
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 May premium.
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 AUGUST/SHORT SEPTEMBER SOYBEAN MEAL
At 30 points September premium, with an objective of 600 points September discount, risking to 300 points September premium.
LONG JULY/SHORT SEPTEMBER SOYBEAN MEAL
At 250 points September premium, with an objective of 300 points September discount, risking to 500 points September premium.
LONG MAY/SHORT SEPTEMBER SOYBEAN MEAL
At 450 points September premium, with an objective of 200 points September discount, risking to 800 points September premium.
LONG 2 NOVEMBER S&P 690 PUTS/
SHORT 2 NOVEMBER S&P 760 PUTS
At 30 points credit, collected twice, with an objective of zero, holding the position as long as the market is above 760.
Closeouts
LONG MARCH/SHORT MAY PORK BELLIES
At 125 and 140 points March discount, closed out at 50 points March discount for a total profit of 165 points before commissions.
October 27, 1997Don Selkin
Prudential Securities, Inc.
One New York Plaza, New York, New York
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