Eurodollar 90 Day interest rate futures are among the most actively traded futures in the world. Given the current state of the market (an extended period of low interest rates), many investors want to figure out how they may trade a changing interest rate price landscape.

This video covers the basics of interest rate futures and how the Eurodollar future (/GE) can be used to gain exposure and take advantage of changing rates and also will show you an example of a trade that you could place if you hold the assumption that the Fed will raise interest rates in the near future.

It’s important to remember that the market expects increased interest rates as well and has already priced that potential outcome into the futures. Its the timing of that increase that varies and affects the shape of the interest rate yield curve.

What Are Eurodollar Futures?

Eurodollar futures are an interest rate products that offer a great deal of liquidity (they are on par with Crude Oil futures and S&P futures). Eurodollar futures are priced over a 10-year span, meaning that the farthest out contract you could trade is 10 years out.

Eurodollar Futures represent the 3 month interest rate on $1 million deposited in overseas banks at some future point (depending on the contract’s expiration). In layman's terms, this is the interest rate you would get for depositing money outside of the U.S..

*Important note: the Eurodollar futures is NOT the same as Euro Currency Futures

Why Would You Trade The Eurodollar Future?

There are a high volume of contracts being traded consistently Because there are so many contracts being traded, it is a liquid product It has contract listings that go out quarterly for 10 years

Where Does The Eurodollar Pricing Come From?

You can find the expected interest rate from the Eurodollar pricing. To do so, you take 100 and subtract the price at which the Eurodollar is trading. The equation would look like this:
100 – (Current Futures Price) = Interest Rate

For example, if the December 2015 Eurodollar futures contract was trading for 99.36, then the equation would be:
100-99.36 = .64%

This would mean that the market expects that the interest rate to be .64%.

Placing A Eurodollar Trade Assuming Interest Rates Will Increase

Treasury futures pricing accounts for the assumption of most investors that interest rates will increase, which would cause the treasury prices to fall in the near future (remember when yields rise, futures prices fall). This results in longer dated futures to be priced lower than the front month contracts.

This is why the shorter end of the yield curve, like 90 day Futures may potentially move more quickly, which provides unique trading opportunities. It’s a more efficient way to have some interest rate exposure.

To find a way to take advantage of a bearish assumption in /GE, Pete first examines the expected interest rate for September 2015 and for March 2016 based on the futures pricing.

The September 2015 price is 99.56, therefore the rate would be .44% (100-99.56). The March 2016 price is 99.15, therefore the interest rate would be .85% (100-99.15).

When we subtract September 2015 contract rates from March 2016, we can see that the markets have priced in an increase of 41 basis points into the futures contracts. If an improving economy forces the Fed to raise interest rates sooner than expected, the result would be that this spread would widen.

To take advantage of this price differential, you would construct this spread:

• Buy a September 2015 Eurodollar Futures Contract (/GEU5)
  
• Sell 2 March 2016 Eurodollar Futures Contracts (/GEH6)
  
• Buy 1 September 2016 Eurodollar Futures Contract (/GEU6)
  

Strategy: Calendarized Butterfly Spread
Due to the fact that this product already prices in changes in rates, Pete suggests doing a spread rather than buying or selling the Future outright.

Products Discussed In This Episode: /GE, /ZB & /ZN