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The Eurodollar Futures and Options Handbook

Book Description

Eurodollar trading volume is exploding, with no end in sight tools phenomenal growth. The Eurodollar Futures and Options Handbook provides traders and investors with the complete range of current research on Eurodollar futures and options, now the most widely traded money market contracts in the world. The only current book on this widely-followed topic, it features chapters written by Eurodollar experts from JP Morgan, Mellon Capital, Merrill Lynch, and other global trading giants, and will quickly become a required reference for all Eurodollar F&O traders and investors.

Table of Contents

  1. Cover Page
  2. The Eurodollar Futures and Options Handbook
  3. Copyright Page
  4. Contents
  5. List of Exhibits
  6. List of Examples
  7. List of Equations
  8. List of Contributors
  9. Foreword
  10. Part One The Emergence of the Eurodollar Market
    1. Chapter 1 The Emergence of the Eurodollar Market
      1. The Revolution in Finance
      2. The Futures Revolution
      3. Key Money Market Developments
      4. Why Eurodollars?
      5. Eurodollar Futures
      6. The Death of CD Futures and the Birth of Eurodollar Futures
      7. The Market for Interest Rate Derivatives at the Beginning of the 21st Century
        1. Exchange-Traded Money Market Futures and OTC Interest Rate Swaps
        2. Options on Futures, Forward Rates, and Swaps
        3. Markets around the World
  11. Part Two Building Blocks: Eurodollar Futures
    1. Chapter 2 The Eurodollar Time Deposit
      1. Maturities and Settlement
      2. Quotes
      3. LIBOR and LIBID
      4. Interest Calculations
    2. Chapter 3 The Eurodollar Futures Contract
      1. Contract Specifications
        1. Contract Unit
        2. Price Quote
        3. Tick Size
        4. Minimum Fluctuation
        5. Listed Contract Months
          1. Contract Month Symbols
          2. Color-Coded Grid
          3. Expiring versus Lead Contract
        6. Trading Hours and Mutual Offset
        7. Final Settlement Price
        8. Last Trading Day
        9. Value Dates
        10. Additional Trading Facilities
      2. Initial and Maintenance Performance Bonds
      3. Volume and Open Interest
      4. Other 3-Month Money Market Futures Contracts
    3. Chapter 4 Forward and Futures Interest Rates
      1. Deriving a Forward Rate from Two Term Deposit Rates
      2. Locking an Effective Forward Lending Rate Using Eurodollar Futures
      3. Important Differences between Forward and Futures Markets
      4. Determining the Fair Value of a Eurodollar Futures Contract
      5. Richness and Cheapness
      6. Forward Rates Are Break-Even Rates
      7. Yield Curve Trades
      8. Finding the Forward Term Deposit Curve Implied by Today’s Futures Rates
    4. Chapter 5 Hedging with Eurodollar Futures
      1. The Tool Is a Eurodollar Futures Contract
      2. Basic Hedge Algebra
      3. Deriving Present and Forward Values from Eurodollar Futures Rates
        1. Calculating a Forward Value (Terminal Wealth)
        2. Calculating a Zero-Coupon Bond Price (Present Value)
      4. Hedging or Replicating Forward Cash Flows
        1. Forward Valuing the Gain or Loss on the Eurodollar Futures Contract
        2. Present Valuing the Gain or Loss on a Floater
      5. Hedging or Replicating Present Values of Cash Flows
        1. Calculating the Price of a Zero-Coupon Bond
        2. Calculating the Present Value of a Basis Point
        3. Finding the Hedge for a Zero-Coupon Bond
        4. Faster Hedge Ratio Calculations with Calculus
        5. Pricing and Hedging a Coupon-Bearing Bond
      6. Managing Hedge Ratios
        1. As Rates Rise or Fall
        2. As Time Passes
      7. Practical Considerations in Real Hedges
        1. The Stub Period
        2. Date and Term Mismatches
        3. Whole Contracts
        4. Credit Spreads
        5. Variable Credit Spreads
    5. Chapter 6 Pricing and Hedging a Swap with Eurodollar Futures
      1. Fixed/Floating Interest Rate Swaps
        1. Notional Principal Amount
        2. Cash Flows in Arrears
        3. Periodicity
        4. Spot and Forward-Starting Swaps
        5. Day-Count Conventions and Swap Yields
      2. Approaches to Pricing and Hedging Interest Rate Swaps
        1. Cash Flow Approach
        2. Hypothetical Security Approach
      3. Pricing a Swap Using the Cash Flow Method
      4. Hedging a Swap Using the Cash Flow Method
        1. Primary Effects
        2. Secondary Effects
        3. Calculating Hedge Ratios
        4. Hedge Ratios Are Dynamic
      5. Pricing a Swap Using the Hypothetical Securities Method
      6. Hedging a Swap Using the Hypothetical Securities Method
        1. Floating Rate Liability
        2. Fixed Rate Asset
        3. Find the Hedge Ratios
      7. Pricing and Hedging Off-the-Market Swaps
      8. Convexity Differences between Forward and Futures Rates
      9. Comparing Three Yield Curves: Forward, Zero Coupon, and Par Coupon
        1. The Difference between Money Market Rates and Bond Yields
  12. Part Three Eurodollar Futures Applications
    1. Convexity Bias (Chapters 7 through 10)
      1. Term TED Spreads (Chapters 11 and 12)
      2. Hedging and Trading with Eurodollar Stacks, Packs, and Bundles (Chapter 13)
      3. Hedging Extension Risk in Callable Agency Notes (Chapter 14)
      4. Opportunities in the S&P Calendar Roll (Chapter 15)
      5. Trading the Turn (Chapters 16 and 17)
      6. Chapter 7 The Convexity Bias in Eurodollar Futures
        1. Galen Burghardt and William Hoskins Research note originally released September 16, 1994
        2. Synopsis
        3. Introduction
        4. Interest Rate Swaps and Eurodollar Futures
          1. A Forward Swap
          2. The Value of a Basis Point
          3. Eurodollar Futures
          4. Reconciling the Difference in Cash Flow Dates
          5. Hedging the Forward Swap with Eurodollar Futures
          6. The Other Source of Interest Rate Risk in the Forward Swap
          7. Interaction between the Two Sources of Risk
          8. Trading the Hedge
        5. How Much Is the Convexity Bias Worth?
          1. How Correlated Are the Rates?
          2. Estimating the Value of the Convexity Bias
          3. Calculating the Value of the Bias
        6. Reconciling the Difference between a Swap and a Eurodollar Futures Contract
          1. How One Would Pay for the Advantage
          2. Translating the Advantage into Basis Points
        7. A Workable Rule of Thumb
          1. Applying the Rule of Thumb
          2. The Importance of Time to Contract Expiration
          3. The Cumulative Effect of All This Drift
          4. How Sensitive Are the Estimates to the Assumptions?
          5. Practical Considerations in Applying the Rule
        8. The Importance of the Bias for Pricing Term Swaps
          1. Biases in Forward Swap Rates
        9. The Market’s Experience with the Convexity Bias
        10. Now What?
          1. Running a Receive Fixed, Pay Floating Swap Book
          2. Marking a Swap Book to Market
          3. Volatility Arbitrage
          4. Evaluating Term TED Spreads
        11. APPENDIX A Deriving the Rule of Thumb
        12. APPENDIX B Calculating Eurodollar Strip Rates and Implied Swap Rates
      7. Chapter 8 Convexity Bias Report Card
        1. Galen Burghardt, William Hoskins, and Niels Johnson Research note originally released April 15, 1997
        2. What Is the Convexity Bias?
        3. How Have We Done?
        4. Convexity Bias Greeks
          1. Convexity Bias Delta
          2. Convexity Bias Vega
          3. Convexity Bias Theta
      8. Chapter 9 New Convexity Bias Series
        1. Galen Burghardt and Lianyan Liu Research note originally released February 1, 2002
    2. Chapter 10 Convexity Bias: An Update
    3. Chapter 11 Measuring and Trading Term TED Spreads
      1. Galen Burghardt, William Hoskins, and Susan Kirshner Research note originally released July 26, 1995
      2. Synopsis
      3. TED Spreads
        1. Simple TED Spreads
        2. Term TED Spreads
      4. Two Kinds of Term TED Spreads
        1. Unweighted Eurodollar Strip Yields versus Treasury Yields
        2. Weighted Eurodollar Strip Yields versus Treasury Yields
          1. Implied Eurodollar Yield versus Treasury Yield
          2. Fixed Basis Point Spread to Eurodollar Futures Rates
      5. How Do These Rates Compare?
      6. How Directional Is the Spread?
      7. Trading the Spreads
        1. Hedge Ratios
      8. What to Do with the Stub
        1. Overnight Financing
        2. Term Financing
        3. Carry and Convergence
        4. Convexity
      9. Forward Term TED Spreads
      10. Term TED Spreads and Swap Spreads
      11. APPENDIX Complete Operating Instructions for Calculating Term TED Spreads and Hedge Ratios
    4. Chapter 12 TED Spreads: An Update
    5. Chapter 13 Hedging and Trading with Eurodollar Stacks, Packs, and Bundles
      1. Galen Burghardt, George Panos, and Fred Sturm Research note originally released December 15, 1999
      2. Synopsis
        1. Three Objectives
        2. How Good Are Stack, Pack, and Bundle Hedges?
        3. Curve-Augmented TED Spreads?
      3. Hedging and Trading with Eurodollar Stacks, Packs, and Bundles
      4. Basics: Dates, Names, Packs, Bundles, and Quotes
        1. Contract Colors
        2. Packs and Bundles
      5. Quote Practices 1: Ticks
      6. Quote Practices 2: Use Price Level for Individual Contracts
      7. Quote Practices 3: Use Price Changes for Packs and Bundles
      8. Unpacking Packs, Unbundling Bundles
      9. Hedging with Stacks, Packs, and Bundles
        1. What Happens to the Correlations?
        2. Best Pack Proxies for Key Treasury Maturities
        3. Horizon Matters
        4. The Dangers of Decorrelation
        5. Scaling Your Hedges to Reduce Hedge Error
      10. Trading Curve TEDs
        1. Calculating the Hybrid Spread
        2. Looking for Opportunities
    6. Chapter 14 Hedging Extension and Compression Risk in Callable Agency Notes
      1. Galen Burghardt and William Hoskins Research note originally released March 24, 1995
      2. Synopsis
      3. Introduction
        1. What Is the Exposure in a Callable Agency Issue?
        2. Extension and Compression Risk
        3. A Packaged Deal
        4. What Is the Package Worth?
        5. What Is the Risk Exposure?
      4. Structuring a Hedge
        1. The Option Is Tougher
        2. Focus on Delta Hedging
        3. Synthetic Forward Notes
        4. Different Deltas
      5. Example of Hedging a 10-Year, 8.5 Percent Coupon Note, Callable in 5 Years
        1. Step 1: Find the Price of the Forward Note
        2. Step 2: Find the Embedded Option’s Delta
        3. Step 3: Calculate Spot Market Hedge Ratios
        4. Step 4: Calculate Futures Hedge Ratios
        5. Step 5: Adjust the Hedge as Interest Rates Change
      6. The Costs and Risks of Delta Hedging
        1. Risks in the Hedge
      7. The Yield Spread between Agencies and Treasurys
      8. What If There Is Little or No Call Protection?
      9. Sometimes Strips of Eurodollar Futures Provide Better Hedges
        1. Netting Positions
        2. Adjusting the Hedges
    7. Chapter 15 Opportunities in the S&P 500 Calendar Roll
      1. Galen Burghardt and George Panos Research note originally released June 7, 1999
      2. Synopsis
        1. Save 15 Basis Points per Year on the Roll
        2. Eliminate Interest Rate Risk in the Roll
        3. Earn Superior Money Market Returns
      3. The Value of the Calendar Spread
        1. Fair Value of the Spread
        2. Implied Financing Rate
      4. How the Calendar Spread Has Behaved
      5. What Is Your Exposure to Interest Rates?
        1. Handling Rate Exposure in the Roll
        2. Hedging against Interest Rate Risk
      6. Cash Management and Portfolio Replication
    8. Chapter 16 Trading the Turn: 1993
      1. Galen Burghardt, Mike Bagatti, and Kevin Ferry Research note originally released October 25, 1993
      2. Synopsis
      3. What Is “the Turn”?
        1. Two-Day Turns
        2. Three-Day Turns
        3. Four-Day Turns
      4. Rate Behavior around the Turn
      5. Effects on Eurodollar and LIBOR Futures Prices
        1. Rule of Thumb for a 4-Day Turn
        2. Rule of Thumb for a 3-Day Turn
        3. Rule of Thumb for a 2-Day Turn
      6. Implied Turn Rates
        1. Implications for Futures Spreads
        2. December LED Spread
        3. December/January LIBOR Spread
        4. December/March Eurodollar Spread
        5. December TED Spread
      7. Effect of the Turn on LIBOR and Eurodollar Volatilities
        1. Theoretical Turn Volatility Premiums
      8. So What?
        1. The Risks in the Trade
    9. Chapter 17 The Turn: An Update
      1. Hedging the Stub
  13. Part Four Building Blocks: Eurodollar Options
    1. Chapter 18 The Eurodollar Option Contract
      1. Option Expirations and Underlying Futures
        1. Standard Quarterly Options
        2. Serial Options
        3. Mid-curve Options
        4. Five-Year Bundle Options
      2. Option Contract Specifications
        1. Contract Unit
        2. Price Quote
        3. Tick Size
        4. Minimum Fluctuation
        5. Strike Price Increments
        6. Listed Contract Months
          1. Contract Type and Month Symbols
          2. Sample Option Quotes
        7. Trading Hours
        8. Last Trading Day
        9. Exercise of Option
        10. Assignment
    2. Chapter 19 Price, Volatility, and Risk Parameter Conventions
      1. Pricing Options on Futures
      2. Option Price (Market)
      3. Volatility
        1. Relative Rate Volatility
        2. Rate (Basis Point) Volatility
        3. Period Volatility
      4. Implied Volatility
      5. Risk Parameters
        1. Delta
        2. Gamma
        3. Vega
        4. Theta
        5. Rho
        6. Intrinsic and Time Value
    3. Chapter 20 Caps, Floors, and Eurodollar Options
    4. Chapter 21 Structure and Patterns of Eurodollar Rate Volatility
      1. Historical, Implied, Realized, and Break-Even Volatilities
      2. Term Structure of Eurodollar Rate Volatility
        1. Volatility Calendar Spread Trade
        2. Yield Curve Trade
      3. Maturity Structure of Volatility (Volatility Cones)
      4. Volatility Skews
      5. Implied Rate Distributions
    5. Chapter 22 Practical Considerations
      1. Early Exercise
      2. Cash Settlement and Exercise
  14. Part Five Eurodollar Option Applications
    1. Trading with Serial and Mid-curve Eurodollar Options (Chapters 23 and 24)
    2. What Happens to Eurodollar Volatility when Rates Fall? (Chapters 25 and 26)
    3. Hedging Convexity Bias (Chapter 27)
    4. Chapter 23 Trading with Serial and Mid-curve Eurodollar Options
      1. Galen Burghardt and Scott Lyden Research note originally released June 22, 1998
      2. Synopsis
        1. Eurodollar Strategy Triangle
        2. FOMC and Other Volatility Trades
        3. Spreads against OTC Treasury Options
        4. LIFFE Joins the Crowd
      3. The Full Constellation of Eurodollar Options
        1. Standard Quarterly Options
        2. Serial Options
        3. Mid-curve Options
        4. Serial 1-Year Mid-curve Options
      4. The Beauty of This Design
      5. The Eurodollar Strategy Triangle
        1. June/Short June (A Yield Curve Spread)
        2. Short June/Red June (A Time Decay Spread)
        3. March/Red June (A Volatility Curve Spread)
      6. Different Volatility Horizons
      7. Mid-curve Options versus OTC Treasury Options
        1. Eurodollar/Treasury Volatility Spread Trading
        2. How Do You Compare the Volatilities?
        3. How Do You Construct the Trades?
      8. Some Things to Keep in Mind
      9. LIFFE’s Options
    5. Chapter 24 Serial and Mid-curve Options: An Update
    6. Chapter 25 What Happens to Eurodollar Volatility When Rates Fall?
      1. Galen Burghardt, George Panos, and Eric Zhang Research note originally released October 18, 2001
      2. Background
      3. Was Volatility Rich or Cheap?
      4. Volatility and Rate Levels
      5. Why Relative Rate Volatility?
      6. What Is the Evidence?
      7. Is it the Fed?
      8. Practical Consequences
    7. Chapter 26 Eurodollar Volatility: An Update
    8. Chapter 27 Hedging Convexity Bias
      1. Galen Burghardt and George Panos Research note originally released August 2, 2001
      2. Synopsis
        1. The Challenges
        2. Overcoming the Challenges
      3. Hedging a 4-Year Swap/Eurodollar Position
        1. Gamma
        2. Vega
        3. Eurodollar Options
        4. Gamma Mismatch?
        5. The Choice?
        6. Robustness?
  15. Glossary
  16. Index
  17. About the Author
  18. Footnotes
    1. Chapter 1
      1. Footnote 1
    2. Chapter 3
      1. Footnote 1
      2. Footnote 2
    3. Chapter 4
      1. Footnote 1
      2. Footnote 2
      3. Footnote 3
      4. Footnote 4
      5. Footnote 5
    4. Chapter 6
      1. Footnote 1
    5. Chapter 8
      1. Footnote 1
      2. Footnote 2
    6. Chapter 11
      1. Footnote 1
      2. Footnote 2
    7. Chapter 13
      1. Footnote 1
    8. Chapter 14
      1. Footnote 1
    9. Chapter 17
      1. Footnote 1
    10. Chapter 18
      1. Footnote 1
    11. Chapter 21
      1. Footnote 1
      2. Footnote 2
    12. Chapter 23
      1. Footnote 1
      2. Footnote 2
    13. Glossary
      1. Footnote 1