Previously, we discussed how market participants can use Eurodollars to hedge floating rate loans by using strips of Eurodollar futures. You might choose to hedge a one year loan (hedge against higher interest rates) with quarterly reset dates by selling four quarterly Eurodollar futures contracts in what is known as a strip hedge. The strip consists of quarterly ED futures strung together.
While strips solved the problem of interest rate risk for some, they came with another issue: creating the strips necessitated legging futures contracts individually. Moreover, longer-dated loans and other hedges would require even longer strips of Eurodollars. Legging each contract individually entailed some risk, as the market sometimes moved appreciably before you could get all the legs completed. There was also the risk of execution mistakes as well as unfilled orders. In response to the marketplace, CME Group developed the concept of packs and bundles to simplify transactions for the increasing number of traders using strips of Eurodollar contracts.
Packs and Bundles: A Logical Evolution
A pack or bundle may be thought of as the purchase or sale of a series of Eurodollar futures representing a particular segment along the yield curve. They may be used to create or liquidate positions along the yield curve. Packs and bundles offer the advantage of being transactable at a single price or value, eliminating the necessity of entering multiple orders in each contract and the further possibility that some orders may go unfilled.
The popularity of packs and bundles is reflected in Eurodollar volume and open interest patterns. Unlike most futures contracts, where virtually all volume and open interest is concentrated in the nearby or lead month, Eurodollar futures have significant volume and open interest in the deferred months going out 10 years along the yield curve. During the first half of 2013, some 14% of all Eurodollar futures contracts were transacted in the form of packs or bundles. In 2016, packs and bundles were approximately 20% of overall Eurodollar volume.
What are Bundles?
A Eurodollar bundle consists of the simultaneous sale or purchase of one each of a series of consecutive Eurodollar futures contracts. The first contract in any bundle is typically the first quarterly contract in the Eurodollar strip, but bundles may be constructed starting with any quarterly contract. CME Group lists bundles in 1-, 2-, 3-,4-, 5-, 6-, 7-, 8-, 9- and 10-year terms to maturity.
Eurodollars are sometimes color-coded to facilitate reference to individual contract months or to packs and bundles. Eurodollars have 40 expirations: four quarterlies going out 10 years. That means there is a March expiration for 2017 as well as 2018 and all the way until 2027. To avoid confusion, CME Group created color codes. White represents the first year, red the second and so on until coppers, which represents the quarterly expiration in the tenth year. The chart below illustrates how bundles are constructed along the entire Eurodollar yield curve.
You may buy a 1-year white bundle by purchasing the first four quarterly expiration Eurodollar futures contracts. This way the entire strip of four quarterly futures contracts are conveniently bundled, eliminating execution risk and promoting efficiencies. Another example, you may sell a 3-year green bundle, which would bundle the first 12 quarterly expiration together in one package. A 5-year gold bundle would involve 20 quarterly expirations all bundled in one transaction.
What are packs?
Packs are similar to bundles in that they represent an aggregation of several Eurodollar futures contracts traded simultaneously. They are designed to represent a series of four consecutive quarterly Eurodollar futures whereas some bundles represent multiples of four quarterly expirations.
For example, you may buy a white pack by buying the first four quarterly expiration Eurodollar futures contracts. Or, you may sell a red pack in the second year by selling the fifth through eighth quarterly cycle month contracts. Or you may buy a gold pack in the fifth year by buying the 17th through 20th quarterly cycle month contracts.
Notice the BPV (basis point value) remains at $100 per pack whereas the BPVs continually rise as you add more quarterly expirations.
Both packs and bundles transacted on the CME Globex electronic trading platform.
Quoting Packs and Bundles
The price of a pack or bundle is quoted by reference to the average change in the value of all Eurodollar futures contracts included in the pack or bundle since the prior day’s settlement price. They are quoted in increments of 1/4 of one basis point (0.01%). E.g., if the first four quarterly Eurodollar contracts have advanced two basis points for the day, while the next four quarterly Eurodollar contracts have advanced three basis points for the day, then a 2-year, or red bundle, may be quoted as +, or up, 2.5 basis points.
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