Playing the yield curve using Treasury options and futures
Fred Day
Jul. 14, 2007

The stagflation in the economy has created interesting scenarios for playing Treasury option spreads and other complex option strategies on the presumption that shorter end of the yield curve will cone down and longer end will go up.

A very interesting analytic study says, when the market makers – the options and futures clearing house specialists manifest extreme bearishness or bullishness through unusually low option premium and spread between the bid and asked prices, the market move in the other direction for the long term.

It happened recently in the cotton futures option. Cotton consolidated for many years before a very recent break through piercing an upper channel at 60 in the nearby contract.

At the very final stage of the consolidation, in the money call options has little spread between bid and asked. What that means is that the market makers had given all hope up on cotton. Cotton took off for a massive thirty percent rally in the last three months.

The similar thing is happening in nearby eurodollar futures. It seems the shorter end of the yield curve is ready to go down in yield very sharply in spite of all talks by the Wall Street commentators that Fed will raise rates and so on.

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