If you have been paying attention to the short-term interest rate markets (STIRs), you undoubtedly know that volumes have fallen off in Eurodollar options.
Fed Policy, December 2008-December 2015
During the Credit Crisis, the Fed cut interest rates to 0-25 bps for the first time in its history. In addition, it was the first time the Fed had used a target range as opposed to a stated basis point (such as 50 bps). During this time, the Fed Funds effective was typically setting between 10-20 bps, so near the midpoint of the Feds target range. At the same time, the TED Spread, the spread between 3-Month Libor and the 3-Month Treasury Bill, was typically in a similar range. This spread is highly correlated to the effective Fed Funds rate. Although a deep dive into the mechanics of STIR plumbing is beyond the scope of this piece, it suffices to say that adding these 2 numbers together gets you close to the Eurodollar futures price. For example, if Fed Funds effective is 15 bps and the TED Spread is also around 15 bps, expect the Eurodollar futures price to be 99.70 (100.00 – 0.30 = 99.70). And that’s how we ended up settling near the 99.75 strike most of the time.
The expectations are that we will once again get to the narrow range in Eurodollar futures that we saw previously. Therefore, most players are once again targeting the 99.75 strike. Most of the positions we have been seeing are 99.625/99.75/99.875 call flies being bought.
What Are The Risks?
Take a look at the TED Spread during the time period between December 2008 and December 2015.