People are putting out their 2011 trades / outlooks so here is a list of my own. Sorted by conviction. I tried to keep it short – feedback welcome.
Sell S&P 1yr Variance swaps
- Forward vol is very high, probably because the pension fund managers are buying long term S&P puts so they can keep their job next time the market crashes. Take advantage. The S&P is not going to average 1.65% of volatility a day over the next year. I see indicative 1yr bids @ 26.4 and 2yr bids @ 30.0. As a reference realized vol over the past 12m is 17.8, or 1.1% per day. Had you done this trade a year ago you would’ve made 10 vol points.
- Risks: a global bank goes under
Buy Fed Fund futures or OIS, for 1Q12
- They are pricing Fed hikes, but it’s not going to happen. Potential profit / vol isn’t great on this trade, but the probability adjusted return vs risk of loss is very good. 1st full hike is priced in for Fed 2012.
- Note that this is good in a book with a pro-cyclical tilt in that it could dampen portfolio volatility.
- Risks: Better than expected US data over the next quarter could send yields sharply higher as people panic that the Fed will halt QE2 early.
Buy EEM vs EAFE
- Pretty straightforward. For those worried that EEM will sharply underperform in a risk aversion event, look @ the ratio between April to August. This trade has the additional benefit of having a low correlation to the S&P.
- Risks: higher EM inflation drives profit taking, like in mid 2006
Buy FCX or copper outright
- Basically an EM inflation play. Fundamentals are good, macro trends are in its favor. The curve has gotten quite backwardated over the past 4 months, and looks set to continue.
- Risks: Cyclical risks, Chinese growth stumbles
- Yes, rate differentials aren’t going to change, but the negative seasonality is neutralized by year end, and PPP as well as rate based regressions suggest 3-4 figures of upside. Outright is probably better than via options due high premium vs drift.
- Risks: a bit of a crowded trade, higher Japanese inflation.
Buy the Dow
- Very cheap vs fixed income, dividend attractive, entering 3rd year of presidential election cycle, low risk of recession, (somewhat explicit) Fed put, strong technicals.