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Picking a Side in the Battle of Yields

by | Tips & Strategies

Every so often a market reaches an inflection point, and traders ask themselves: is this a flash in the pan or is the landscape actually changing? Examples include the British pound’s decline following the initial Brexit vote (it rebounded) and GameStop stock earlier this year (GME is up around 1,000% YTD*).

The US yield curve is currently in the midst of this exact conundrum as traders debate whether or not 10YR rates will continue to outshine both shorter- and longer-term equivalents.

The Case for Consistency

Only time will tell, of course, if the yield curve moves further into uncharted territory or reverts back to normal. So, which side will you be on? In times like these, consistency can help. Were you selling pound puts in 2016 or buying them? Did you ride the GME wave to new heights or sell shares short?

The Butterfly Spread (2*S10Y-S2Y-S30Y)

The Butterfly Spread (2*S10Y-S2Y-S30Y)
Source: dxFeed Index Services (https://indexit.dxfeed.com)

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How to Execute Your Opinion

There are many permutations of yield curve trades with just the Small 2YR, 10YR, and 30YR Yield futures, but the strategy referred to below employs all three – the butterfly spread. Traders thinking that the extreme won’t last can sell it, while trend-followers can buy it.

The Butterfly Spread
Short Long
+1 S2Y \ -2 S10Y \ +1 S30Y -1 S2Y \ +2 S10Y \ -1 S30Y

A new craze pops up every week, it seems, and keeping your opinions consistent may help you act quicker.

*As of 3/18/21

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