Monday, May 21, 2012

Millennium Fly

One of the most legendary moves at the CME easily involves the "millennium fly" which was a butterfly spread based upon the September 1999, December 1999 and March 2000 eurodollar contracts.  The fly was a concentrated play upon interbank funding at the turn of Y2K and became far more volatile than any such spread before or since.  

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Like most eurodollars butterflies, the millennium fly had a typically tight range but suddenly exploded upward in November 1998 from about 20 to over 80 in about a months time with the majority of the move coming in a couple weeks.  Even though it was before my time in Chicago, it still hurts to look at the chart knowing the pain such a move could and did inflict.

I don't know if the catalyst was a desk trade recommendation at the time of the breakout but the web magazine Derivatives Strategy noted in the following article: A Trade for Millennium Jitters

"The underlying justification for the trades is that investors may express their aversion to Y2K computer snafus by moving money out of deposits in software-laden banks and into fixed-income securities, such as Treasuries or bearer paper. This could put a squeeze on bank liquidity and drive up money-market rates in December 1999, relative to levels in either September 1999 or March 2000. To take advantage of this spike for the eurodollar, Sturm is recommending selling two December ‘99 eurodollar futures and buying one each of the September ‘99 and March ‘00 contracts.

“If you analyze the performance of a year-end ‘butterfly’ over the last 10 years, you can see that, with six quarters to expiry, you have a 90 percent confidence that it will be priced between one tick and 15 ticks,” says Sturm. “By that stage this year, however, the millennium eurodollar butterfly was trading at 18 ticks, which you can approximate as the price tag that the market is putting on the potential financial disruption of Y2K.”

Click to enlarge

As the article also noted, there was a similar scenario in the Japanese interest rate market and the trade to focus on Y2K funding in the euroyen was known as the "dragon fly."  This trade was structured differently because of the March 31 fiscal year end in Japan and the dragon fly was positioned like an unratioed condor EYU99-EYZ99-EYH00+EYM00.

Really amazing stuff and another case that the only thing that matters is liquidity.  Just as amazing is that the desk recommended the trade at the beginning of the move.

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