I was reading a report last week that
“the carry on a 2s5s gilt curve flattener is negative to the tune of 10bp over 6 months”
and I realised I have little understanding of this concept and how this cost is calculated since the only cost of carry I ever studied in was storage costs for commodities in futures formulae in college.
There was a surprising lack of literature I could find on curve flattener cost of carry but I did find this thread Roll down and Carry for 2/5 on the Wilmott Forums which gave a ballpark formula as
Ballpark formula is fine for me since this is just an intuition exercise. Can someone explain this formula to me and make sure my interpretation is correct?
- DV01: Portfolio sensitivity to yield changes
- 2s5s slope: the return from selling the 2yr position and buying the 5 yr in the bear flattening position
- 5y1y/2y1y: the costs of buying and selling the positions in one years time when I exit the trade
Based on my calculations I see a positive carry of roughly 100bps over the 1 one year period which seems a good bit off the broker research I read so I'm wondering am I confused somewhere or missing something as I was expecting negative carry.
My DV01 is the average of a short gilt benchmark over the last two years and I calculated the rates one year from now by simply strapping the curve
$$5y1y: (1+y_5 )^5 (1+f_1 )^1=(1+y_6 )^6$$
$$2y1y: (1+y_2 )^2 (1+f_1 )^1=(1+y_3 )^3$$