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I think: when Fed stops QE (Quantitative Easing), Treasury Futures prices will go down.

Question 1: Am I right?

So... buying LEAP Puts (in Treasury Futures) would be a good idea.

Question 2: Am I right?

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Not saying this trade won't work, but there's certainly no guarantee that it will...

  1. Given that QE will stop in October is well teleported at this point and has been expected since last year, you'd think this should be fully priced in.

  2. Last year, when the "tapering" talk started, Treasuries did sell off quite a bit, but has since rallied all the way back. Clearly, QE is not a major factor driving interest rate markets nowadays.

  3. There's always the chance that stopping QE and other accommodative monetary policies would have negative impact on the economic growth, causing bonds to rally further.

  4. Despite what some people might believe, it's not clear the Fed has that much power controlling longer maturity yields. In 2004-2005, when the Fed was hiking, 10y notes were busy rallying.

  5. Shorting Treasuries is a terribly negative carry trade. As of Friday, 10-year yield was about 2.35%, while 1y forward 10y par yield was about 2.73%. So for the next year, 10y yields have to sell off by at least 38bp for you to make money (i.e., you can still lose money even if interest rates are higher!) It's even worse for 2s, a fully 100bp of rate increase has already been priced in.

Since you're using options, you'd also be bleeding time carry, etc.

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  • $\begingroup$ Fantastic points. Thanks. Couldn't upvote because I don't have the min. 15 rep. $\endgroup$ – thanks_in_advance Aug 31 '14 at 23:23
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    $\begingroup$ I don't understand point 5... anyone could elaborate a bit? $\endgroup$ – athos Sep 1 '14 at 7:08
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    $\begingroup$ @user1883050: Now you have your min. rep (I just upvoted your question :-) $\endgroup$ – vonjd Sep 1 '14 at 8:21
  • $\begingroup$ @athos Treasuries are an income-producing asset - you receive regular income just for holding them. If you are short, you need to pay those cashflows. In addition, a long treas. position will "roll down" an upward sloped yield curve, giving capital gains even if rates don't move (capital losses for a short position). So rates need to move quite far in your favour (38bp) for you to break even, before you start thinking about profit. This is what's meant by "negative carry". $\endgroup$ – Chris Taylor Jan 19 '17 at 19:08

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