Bonds/Swaps/Futures Funding Arbitrage
Please note, as ART Consulting/Research is a fee based
service, in the following the results have been "sanitised" to
disguise the specific markets, trading factors, strategy parameters and many
other essentials. Of course, all of the analyses is based on real market
conditions and real world trading considerations (trans cost, funding, etc). For access to the
"un-sanitised" results, and for analysis tailored to your needs please
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Even apparently simple, and what is
otherwise considered well understood trading may lead to arbitrage
opportunities. For many years the "markets" had not fully accounted
for the "delivery option" in US Bond Futures, providing arbitrage
opportunities. In a similar manner, the funding relationship in the
Bond/Swap/Bond-Futures complex may also give rise to conditions that are arbitragible.
This type of arbitrage arises due to a
variety of factors involved in the "arbitrage free" mechanism built into
fair value pricing, and importantly also due to the way in which the funding
process is managed/traded. In the real world, the funding process is
almost never consistent with the assumptions of the pricing mechanism.
This abridged note provides only a
cursory illustration of just a few holding period P&L results using
different rebalancing and structuring strategies under real market
conditions. In each case, some combination of bond/swap/bond-future
position was examined with different funding strategies.
As is customary at the ARBLab, PaR
analysis is performed
on various structuring and rebalancing strategies. Other examples of
PaR analysis and the Pr/rO ®
software are provided in the ARBLab
Samples section, such as ARBLab:
P&L Optimal Options Rebalancing - 1,
while all of
- Chapter 12 is
dedicated to the introduction of PaR analysis.
image to right (click to ENLARGE)
shows an interpolated surface for 1809 net-P&L's resulting from 1809
trades, each being held and rebalanced as required by the
structure/strategy under consideration. The quality of the data is
critical. Here only two of the many "dimension" (Factors X & Y)
are shown. These factors are real world measurable quantities such as
prices, vols, moving averages, etc. This surface already illustrates
that funding process is "too expensive" due to the various interactions of
the funding trades, implied repos vs. actual repos, holding period
mandates, and important correlations (most of which are not accounted for
in traditional valuation and risk methodologies).
alternate set of strategies/funding process are shown in the image to the
right. This surface is the interpolation of 2421 trades. It
has a very different character compared to the surface above. Here
too, the funding process is inefficient.
However, consider that these two strategies/positions could be
taken on simultaneously and to offset one another. In this case, though
not purely risk free, it is a very low risk trade which produces an average
return comparable to nearly risk free consistent 1-2/32'nds per contract in bond/bond-futures terms.
Notably, some of the approaches to exploit such arbs
are better suited to large trading operations and market makers, where there
are large frequent flows, and low transactions costs.
As usual, caution is required.
The analysis here, though including thousands of trades, and incorporating
many real world factors cannot be taken as any perfect predictor of the
future, and additional specific analysis may be required for your due
For detailed research results on this issue please
More Information and please feel free to indicate specifics of
interest to you.
example, a "Bond + Warrant" is often included in the CB family of trades,
but this is not a strict CB. With a strict CB, you may only own one or
the other security at any one time, while with a B+W it is possible to end
up holding both shares and bonds simultaneously.
2 "Easy to
trade" instruments are those that are easily accessible, liquid, low
transaction and warehousing costs, and so forth.
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