Barclays Capital is recommending clients buy receiver swaptions because it does not think the Federal Reserve will tighten monetary policy as quickly as the forward curve implies. Brad Stone, head of U.S. fixed-income marketing and derivatives strategy in New York, said the trade is based on his assumption that while the recent flattening of the yield curve will reverse over the short-term, he expects a "bull flattener" starting late in the fourth quarter. "We see the pullback in short swap rates as an opportunity to put on carry trades in the short-end of the swap curve. A carry trade is a trade that is based on the belief that rates and the curve are not likely to change, Stone said. "Where the rates are going to be in six months is similar to where they are today," he predicted.
In a typical trade the investor buys a six-month option on a two-year swap struck at-the-money forward. For example, with a premium of 65 basis points the investor wins 33.5bps of net profit if two-year swap rates are at today's level when the swaption expires in six months. The maximum the investor can lose on the trade is the up-front premium. That would occur if two-year swap rates are at or above the forward strike.
The trade is aimed at hedge funds, investment banks and money managers. The typical notional size is USD100 million.
