Home » Trade Ideas: Hedging of Cleared LIBOR Swap Exposure

Trade Ideas: Hedging of Cleared LIBOR Swap Exposure

>> Efficient Hedging of Cleared LIBOR Swap Exposure

Substantial margin offsets between correlated futures products traded on open platforms broadens access for new liquidity providers to enter swap derivatives market

The Trade

A Liquidity Provider – either a bank swap desk or Principal Trading Group (PTG) – electronically streaming a two-sided  market for a 2-year swap derivative has its offer to receive fixed on $50M notional lifted by another market participant, then automatically executes a hedge in a correlated electronic market

Alternatives

 

OTC 

  • Liquidity Provider streams par swap quotes to a Swap Execution Facility
  • Another participant lifts the offer to receive fixed on $50M 2-years at a rate of 0.503%
  • Liquidity Provider hedges position by selling cash treasuries, selling CME Eurodollars, or paying fixed on a par swap at a different rate in the dealer-to-dealer market (if accessible)

            

  • Liquidity Provider streams two-sided quotes on Eris IMM dated benchmark contract on Eris SwapBook with standard fixed rate of 0.500%
  • After the offer to sell (receive fixed) is lifted, Liquidity Provider hedges position electronically by selling a 2 year strip of Eurodollars on CME Globex                                           

 

Implications

 

OTC                                

  • Liquidity Provider does not receive margin offsets for trades at different clearinghouses
  • Liquidity Provider using cash treasury hedge must still manage swap spread risk
  • Liquidity Provider using nearly-offsetting par swaps faces inefficiencies of line item proliferation
  • Additional pay fixed trades will create further line item proliferation

    • 

  • Liquidity Provider will experience Initial Margin savings in excess of 70% at CME Clearing
  • Significant correlation between Eris futures and Eurodollar prices at short end of curve ensures effectiveness of hedge performance over time
  • Concentrated liquidity within Eris benchmark futures helps ensure Liquidity Provider can exit position efficiently
  • Additional trades in the benchmark contract will not cause line item proliferation

 

Eris Exchange Savings

 

 

Futures Hedge

5-day Price Correlation with Futures Hedge

Margin Offset with Futures Hedge

Tick Value

Exchange & Clearing Fees (Customer Rate)

Eris 2y IMM

2y ED Strip

97%

Avg 72%, Max 89%

$50

$5.00

Eris 5y IMM

5y ED Strip

98%

Avg 78%, Max 86%

$50

$9.00

Eris 10y Invoice Spread Leg

10y Treasury Future

~89%
(Varies with CTD)

Avg 58%, Max 75%

$100

$16.00