1
$\begingroup$

In a basis trade, if you short the Treasury futures and buy the underlying bond and hold it to maturity, is funding the only source of risk assuming there no CTD switches. You have locked in the financing rate (repo) on the bond and the futures leg doesn't require financing. Your return would be implied repo - actual repo.

Is there a way to enhance the return you earn and is this practical? For example, can you lock in the repo and receive OIS swap rate, then paying rolling overnight Fed funds rate. The cash flow you're left with is

implied repo - actual repo + (OIS - rolling overnight Fed Funds)

If rolling overnight Fed Funds = OIS rate that you locked in, then your return is just implied repo - actual repo + 0

However, if rolling overnight Fed funds < OIS rate, then your return would be higher: implied repo - actual repo + (OIS > rolling overnight Fed Funds).

Improve this question
$\endgroup$
2
  • $\begingroup$ OIS is just the implied rolling overnight fed funds rate over the duration so OIS - rolling FF should be = 0 $\endgroup$
    – Lliane
    Commented Jun 28, 2019 at 6:30
  • $\begingroup$ And if you think that OIS > rolling overnight fed fund just buy the swap. $\endgroup$
    – Lliane
    Commented Jun 28, 2019 at 7:19

1 Answer 1

Reset to default
1
$\begingroup$

I think you have the hedge wrong way around. You want to pay fixed /rec ois to the delivery date. Then your p/l will be (implied repo -fixed rate on ois swap) + (daily ois rate -daily repo rate).

The idea is that the first term is a fixed positive number (say 20bp) and the second term you hope stays around -5bp through the life of the trade.

Improve this answer
$\endgroup$
2
  • $\begingroup$ Thanks, that makes sense. However, why cant you do (implied repo - fixed repo) + (ois fixed - daily ois). In the second term, you expect to receive ois fixed because you think daily ois will fall more than what's implied. $\endgroup$
    – VanillaCall
    Commented Jun 29, 2019 at 16:49
  • $\begingroup$ You could do that , but it amounts to a straight interest rate speculation. Nothing to do with bonds or repo. $\endgroup$
    – dm63
    Commented Jun 29, 2019 at 19:27

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.