5y US Swap 1

Majors Fixed Income

Rationale: We believe the greatest risk to many portfolios, particularly those with emerging market and equity
exposure, is a chaotic unwinding of US Treasury positions or even a wholesale repricing of future Fed action. While the
Fed and market dynamics should be able to contain a liquidity driven panic move higher in both the front and back end
of the rates curve, we see the 5 year as being the hardest to assess and therefore potentially being the most vulnerable
to a dramatic shift.
Although it remains a low probability event, after
witnessing the liquidity vacuum of a couple of weeks ago, it
is a contingency we believe warrants protection, especially
if it can be obtained inexpensively. With skew having come
down to extremely low levels (see Skew chart) and atmf
vols still high after having jumped up on the back of the
flash crash (see Vol chart), we have an opportunity to
potentially profit from this outcome without paying
anything, so long as the 5 year swap winds up anywhere
below 2.31% at expiration. That is a level that has held since
2011 and is likely a key level to watch for a potential break
higher (see Spot chart below).
By selling the 6 month 35 delta payer on the 5 year US Swap,
we are taking advantage of the elevated atmf vols. By
combining that with the purchase of 2.65x the notional of
the 15 delta payer with the same expiration, for net zero
cost, we are taking advantage of the relatively low skew.
If nothing happens, which we believe to be the most likely
outcome, we neither gain nor lose. However, if the market
suddenly begins to reprice the likelihood of a faster, more
robust Fed, then our tiny net short DV01 position will
rapidly grow. If the move higher in rates is accompanied by
higher vols and bigger skew, both of which we believe will
be the case, then the delta exposure grows that much faster
and the long vega exposure will also quickly develop to our
advantage.
If rates quickly fall, we can purchase back the short position,
leaving just a lottery ticket on the books and wait to reestablish again on a spike higher. Hence, RA Trigger #3.
Simply stated, this position doesnt produce delta, vega or
theta exposure of real significance until that moment when
you want it. It is designed to benefit from a jump in rates,
shift higher in vols or spike in skew. Any combination
thereof should improve the return, with the greatest
benefit occurring upon a simultaneous move in all three,
especially early on. The maximum downside is capped.

Risk Factors: The greatest risk is a slow, grinding shift higher in interest rates.
Please see important disclaimer.

Trade Details
Trade Date

Expiration

Currency

Option Type

Strikes

November 6, 2014

May 7, 2015

USD

Payer Spread

2.31 & 2.69%

Implied Vol

Price

CaR as % AuM

0.65 & 0.245%

2%

Spot

Points

Forward

1.8115%

0.22

2.09%

Reassessment Triggers

Expectations

1. Expiration
2. 5y US Swap at 3.0%
3. 5y US Swap t 1.5% possibly buyback short strike

Vol Skew Higher

Vols Higher
Rates drift back lower
Vols Lower

Post Mortem Analysis

Reason for Trade Unwind
Spot

Points

Forward

Implied Vol

Price

Rtn on CaR

Return to Fund

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Advisors is not liable for any loss or damage resulting from the use of its product. Futures, forward and options trading is speculative, involves substantial risk and is
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Please see important disclaimer.