At any time, 40 quarterly Eurodollar futures contracts are being traded. Although the volume of trading falls with the longer expirations, there is generally no problem with liquidity through the next five years. On Nov. 28, 2014, the volume for the March 2015 contract was 64,600. For the December 2018 contract it was 11,125.
“Yields and rates: Nov. 28, 2014” (below) shows the 40 quarterly Eurodollar rates on that date. The yield curve that these rates produce is a series of geometric means of successive quarterly rates that extend over the 10 years of maturities. At the five-year maturity, the Eurodollar yield curve is only 25 basis points above the U.S. Treasury yield curve. The chart shows that the rates for Eurodollar futures are determined by the shape of the U.S. Treasury yield curve. Because of the relationship between the curves, they are affected by Federal Reserve Bank policy decisions.
The Eurodollar rates-to-yields chart for Nov. 28 shows the ratio of each quarterly rate to its computed yield. On this chart, it is obvious that the rates through the first nine quarters are assigned the heavy lifting duties, providing enough elevation for the yield curve to permit its continued parallel tracing of U.S. Treasury yields. The resulting rate-to-yield curve tops out at a rate approximately twice the corresponding yield for the December 2016 Eurodollar futures contract.
The increasing ratios of rates-to-yields through the first nine quarters on Nov. 28 provide a suggestion for spread trades between Eurodollar expirations. Examples of the speed variations between rates are shown by the vertical distances as they increase from the top of the rate-to-yield curve down to quarters 1 and 2.
On the other hand, note the slow progression of rising ratios extending toward the 10-year maturity. Buying a futures contract near the peak of the rate-to-yield curve, and selling one that is further from expiration and with a rate that is falling at a slower speed may result in a profitable spread.
Because Eurodollar futures are continuously moving toward their expiration dates, it may be possible to spread between contracts that are more closely connected. This could include time spreads of a few weeks or months.
The charts in “Yields and rates: April 8, 2011” (below) show the beginning of a longer-term Eurodollar legacy spread. The peak of the rate-to-yield curve is at quarter number 7, which is the December 2012 futures. For purposes of the longer-term trade, the contract chosen to buy is December 2015 with a rate of 4.575%. The futures contract sold on April 8, 2011 is December 2019, at a 5.555% rate.
When the spread is closed out on Nov. 28, 2014, the rate on December 2015 Eurodollar futures is 0.75%. The December 2019 futures rate has also fallen to 2.960%. The difference in rate declines, 3.825% for December 2015 and 2.595% for December 2019, is 1.23%. At the Eurodollar futures price change of $25 per basis point, the gain on the trade is $3,075.
The legacy trade has performed as hoped, but not without risk because of the changing shape of the yield curve. If the trade had been closed out on March 7, 2014, instead of waiting until Nov. 28, the result would have been different. On March 7, the December 2015 futures rate was 1.075% and the rate on December 2019 futures was 4.235%. Thus, the trade begun on April 8, 2011, would have produced a profit of $5,550 if closed out on March 7, 2014, instead of waiting until Nov. 28. This also means that the same trade, if begun on March 7, would have lost $2,475 through Nov. 28.