The prices, yields and quarterly interest rates of eurodollar futures are closely associated with U.S. Treasury yields. “Yields and rates” (below) shows the Treasury yields at six maturities on eurodollar futures on Feb. 24 with rates for 40 quarterly maturities beginning with March 2017, and the eurodollar yield curve computed as the geometric mean of quarterly rates leading up to each maturity. Because of the closely matched yield curves, the Treasury yield curve can also be thought of as a series of geometric means of quarterly rates.
The usual price quote for a eurodollar futures contract is one hundred less the contract’s 90-day interest rate. A change in price is equal to the number of basis points (one basis point is 1/100 of one percent) that the rate changes times $25. For example, on Feb. 22, 2017, the March 2020 eurodollar futures price was 97.6450 and the quarterly rate was 2.355%. On the previous day, March 2020 futures closed at 97.6400 with a rate of 2.360%. The dollar price was lower on Feb. 22 by $12.50 due to the half basis point increase in the rate.
Because of the goal of having the eurodollar yield curve match closely with the Treasury yield curve, each quarterly eurodollar rate must be carefully placed to produce the correct eurodollar yield curve. As the “Yields and rates” chart shows, the futures market does an outstanding job of holding the eurodollar yield curve close to the Treasury curve. After starting with a wide variation at low maturities on Feb. 24 due to liquidity introduced into the market by the Federal Reserve Bank, the two yield curves become close at the five-year maturity. This means that eurodollar futures can provide a hedge for trades in Treasury securities
Now look at “More yields and rates” (below). At that time there was an even greater impact on interest rates from the Fed’s policy of quantitative easing; however, the eurodollar yield curve was much closer to the Treasury curve.
For the proposed trades it is not necessary for the eurodollar yields to match the Treasury yield curve. We are looking for differences and changes among the eurodollar futures quarterly rates, with the knowledge that central bank policies will cause some of the changes used in the spread trades.
Although the differences are hardly noticeable in the 40 quarterly eurodollar rates, there are trading opportunities presented by seasonal price changes. Every full year of eurodollar futures maturities contains at least the following four expiration months: March, June, September and December. These four months will represent the seasons: spring, summer, fall and winter. By arranging spread trades between the seasons, it is possible to profit from eurodollar futures rate changes with relatively low risk.
“Eurodollar seasonals” (below) shows the change in rate from the previous quarter divided by the previous quarter’s rate as of Nov. 28, 2014 for each of 40 contracts. This chart of change ratios shows a relatively smooth curve progressing from the highest ratio for the change from September to December through the lowest ratio for June to September. At the top of the change ratio curve are potentially profitable spread trades, including December – September, March – December, June – March, and September – June. Those at the top of the curve have already performed their duties, so for our example trade we need to look for futures with later expiration dates for the spread trades that can be completed in the years following 2014. Because the current month is February 2017, we will choose that time for the first trade example.
The second chart in “Eurodollar seasonals” includes the ratios of changes from previous quarters for September to December, December to March, March to June, and June to September. The sizes of spreads extend from the largest (September to December); to the smallest (June to September). Similar to the seasonal spreads on Nov. 28, 2014, the significant spreads are at the upper left of the curve, with September to December as the highest spread.
“Inside the numbers” (below) presents the results of spread trades applied on Nov. 28, 2014 and completed on Feb. 24, 2017. Eurodollar futures contracts included are March 2017, June 2017, September 2017 and December 2017. The table shows rate changes that are all negative from 2014 to 2017 with resulting increased prices for each contract.
Because of the spreads — one futures contract bought and the other futures sold — the dollar profits or losses are small for this set of spread trades. However, the trader may pick any time to end the trades and would probably choose a more profitable time. For any period, the spreads make the trading extremely low-risk since you are buying and selling two highly correlated contracts.
“Choosing other dates” (below) shows the same set of spread trades closed out on June 15, 2016, Aug. 18, 2015 and June 28, 2016. Both of the earlier closing dates produced more profitable results, with the best outcome shown on June 15, 2016, two years following the initiation of the trades. Because of the relief given by low margin requirements on spreads between adjacent expiration months, even the more modest results look fairly successful.
Results for the spread trades suggest that it may be easier and more profitable just to use the most dependable season for the trade – winter – and spread between September and December. Only one of the nine winter season spreads showed a small loss while several had substantial profits. However, this strategy might lose the chance for a larger profit on one of the other seasons. In effect, there may be a reason for every season in trading Eurodollar seasonal rate changes.