Today’s Carry Trades
November 5th, 2006 by Ian
With interest rates on currencies ever changing, so do the spreads on the interest rates, as well as the exchange rate between the currencies. When making a carry trade, you want the highest yield spread possible, and the most stable exchange rate possible (conditions favoring the currency you are buying are even better of course.) Let’s take a look at some of today’s potential carry trades:
- USD/JPY
- Over the last three months, it went from 114.50 to 118.00. One lot would have returned to you $3181 + $1667 carry interest = $4848. Using 10:1 leverage you would have made a 48.48% return in three months.
- Current yield is 5%
- Looks riskier now that the Fed isn’t raising rates anymore and that the rates in Japan looks like they are going to slowly go up. An additional risk is what will happen with the Chinese Yuan.
- GBP/CHF
- Before August this pair looked extremely stable it oscillated in the same range for about sixteen months. Over the last three months one lot would have given to about $4000 + $1400 interest = $5400. With a similar margin risk as the other pair under review (GBP lots are much larger), the return would have been 28.4%.
- Current spread is 3%
- Hitting highs. The week hasn’t closed this high since early 2002. It’s much less predictable than before August.
- NZD/JPY
- Largest carry spread. Gained 850 pips in the last three months for a total of $8500 for one lot. Interest adds $1172 to total $9672. Using margin to keep risk the same as other pairs here (NZD smaller lot than others) this gives a 144% three month return.
- Current yield spread 7%
- Trading against the Yen is tricky with the event risks. Many traders have switched to the Swiss Franc which isn’t as great, but seems safer with less event risk.
Some other more exotic carry trades are the USD/MXN or EUR/MXN. This gives a large spread with the Mexican Peso yielding 7%. However the peso of course isn’t as liquid can move much faster and more unpredictably. Notice however USD/MXN does have a fairly consistant range between 10.00 and 11.00. CZK/HUF (Czech Koruna against the Hungarian Forint) is also interesting as they are both eastern european nations and the the spread between them is high ~5%. Again, the risk here is unpredictability. Not long ago the forint buckled hard because of a riot.
[…] [For the uninitiated, the basic concept behind averaging down is to “scale” into a position and thereby improve one’s entry price. If you purchase 100 shares of GOOG at 466, and another 100 at 430, your average price will be 448, which is a vast improvement on your initial entry. Overeager traders use this as a “crutch” that allows them to take small initial positions to avoid missing out on potentially big moves, and then add to those positions if the trade moves against them. Others who are carry trading might take the interest they are earning and “reinvest” it in the position, even if it has moved against them in the meantime. In a market like foreign exchange, where the bid-ask spread is the primary cost of a trade, averaging down becomes even more cost-effective, in that no additional commissions are being paid each time a new portion of the position is taken on.] […]