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  • Dani

The Negative Rate Paradigm Shift

In a world where the FED decided to buy junk bonds, nothing is impossible.

Last week I watched an amazing interview, where Raoul Pal from Real Vision talked with Hugh Hendry about the possibility of Negative Rates. Hugh argued that as the banks are not lending, and the velocity of money is below 1 in all major countries (still 1.2 in U.S), there is one move by the FED that can stimulus the economies out of this potential depression. It's going to negative rates.

While you don't have to believe it, you can hedge your portfolio from such a scenario, and do that with small position sizing and a big potential Risk / Reward.

The GE futures (Globex Euro Dollar) are futures with 2500 multiplier and the contract is valued at 100 minus the 3-m London interbank rate. (each 0.01 price points = 25$ per contract).

At the 100 level the rate is Zero.

Looking at the GE future options, we can buy Mar22 Call100 for 0.02$ (50$ per option).

This is a beautiful example of asymmetric R:R trade, where we risk only small amount and have the potential for 10X or even more.

Actually the FED don't need to go to negative, just that the market can give that some higher probability, in order for such a trade to make money.

As someone who believes that the world will go back to normal once the vaccines are approved, I am risking a small amount to hedge my long stocks portfolio against another shock in the markets. The probabilities for winning in this trade look small right now, but the R:R is very interesting, and it looks like a cheaper way to hedge my portfolio in that way instead of buying Puts on equities for example.

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