Trade Ideas: Invoice Spread Trading

>> Margin Efficiency Invoice Spread Trading

Trading invoice spreads with date-aligned Eris Exchange Swap Futures and CME Group Treasury Futures provides end users with unparalleled margin and transaction cost savings

The Trade

Hedge Fund takes a directional position on 10-year swap spread rates, using CME Group Treasury Futures instead of cash treasuries to simplify clearing, settlement and repo complexities

Alternatives

OTC

Hedge Fund calls Bank A to trade a 10 year CME Group Treasury future contract against a DV01-weighted OTC par swap with terms matching the Cheapest-To-Deliver treasury instrument (CTD)
Counterparties report CME Group Treasury future trade to CME as block trade or EFR (Exchange for Risk)

Hedge Fund trades 10 year CME Group Treasury future against a DV01-weighted Eris Exchange Benchmark Invoice Spread Leg, with dates aligned to CTD and a standardized fixed rate
For trades in excess of the CME block trade threshold, Hedge Fund can negotiate package bilaterally, with counterparties reporting each block leg to its respective exchange

Implications

OTC

Hedge Fund pays Initial Margin on the Treasury futures leg and Independent Amount (IA) on the OTC swap
End users are not eligible to receive margin offsets between cleared swaps and futures
Prime Broker may provide financing for OTC IA, for a fee, based on net risk of the positions

Hedge Fund receives substantial reduction in Initial Margin for offsetting futures positions
Standardized fixed rate benchmark contract structure concentrates open interest and reduces total cost of unwinds
Market makers stream continuous electronic orders for price discovery on Eris leg

Eris Exchange Savings

Total savings of trading an Eris invoice spread instead of an OTC invoice spread are a function of the individual firm’s cost of funding, and the holding period for the trade.

	LIBOR Leg Initial Margin	Treasury Future IM	Total Initial Margin	6 Month Carrying Cost	Total Cost (bpa)
Uncleared OTC	$3,229,633	$1,232,550	$4,462,183	$66,016	0.98
Cleared OTC	$3,229,633	$1,232,550	$4,462,183	$66,016	0.98
Eris Exchange	$3,229,633	$1,232,550	$2,063,710	$30,532	0.45
Total Savings w/Eris Exchange			$2,398,473 (54%)	$35,484	0.53

Margin calculations assume OTC/Eris notional of $100mm, carrying costs assume 3% funding cost. Data is from May 7, 2012. Historically, margin offsets on invoice spreads average 58% savings, with a maximum of 75%.