In this post I present some tips on how to understand fixed-income trader jargon.
If you are a quant working closely with swaps or options traders (as I was once), then you won’t get very far in a discussion unless you have a certain amount of fluency with the following terms.
Some were passed on to me in my early times as a fixed-income trader, and others are my own inventions — mnemonics I designed which help me to see a simple logic in a terminology or mathematical equality.
The universal principle, version 1
The largest part of a quant’s time is spent on swaps and swaptions, and therefore swap rates are the most familiar object. But, to be able to speak to rates traders you need to make a fundamental change to your point of view:
The universal principle (v1): it’s all about bond prices.
Once you have that sorted in your mind you are already well on the way to having a fruitful conversation with a fixed-income trader.
By the way, this is version 1 of the universal principle because we’ll later see that buy/sell terminology is often also used for swaps (rather than pay/receive), and at that point we’ll write the real universal principle.
For example, if the bond market rallies then prices are heading north, so interest rates are heading south, and viceversa in a sell off. So when you talk to a trader you should remember:
rates rally = interest rates get smaller,
rates sell off = interest rates get bigger.
Just to state the obvious, the terms rally and sell off are used in all types of markets (eg equity, commodity, fx, vol) and just mean that prices go up (rally) or go down (sell off).
The fundamental relationship: bonds and swaps
My early days on the trading desk were a busy time, and among a thousand things to do I was given a life-changing piece of information to learn by heart:
The Bond & Swap Relation: Long = Receive, Short = Pay.
Explanation: if you receive fixed in a swap (so pay the Libor leg), and rates go down then you will have made money on the swap. When rates go down bond prices typically go up, so when you receive (short for “receive fixed”) in a swap you will likely be happy if bond prices go up, ergo you are long the market.
Corollary for Swaptions: Long = Receiver, Short = Payer.
Note: a “receiver” swaption is an option to enter a swap where you receive fixed.
The fact is that you won’t get very far in any fixed-income trading conversation unless you learn these few equalities by heart and make them second nature. There is more to come, but for the moment let’s see how these rules help us understand a few well-repeated comments:
1) If you buy a bond then you hedge your interest-rate risk by paying in swaps.
2) If rates are low then clients will likely be looking to hedge their fixed-income portfolios by paying in swaps. Explanation: rates are low, meaning bonds are expensive, so most investors will think that bond prices are more likely to go down than up, so shorting the market is probably the most popular position; hence paying in swaps since that is a synthetic short.
3) A call option in the equity world is an option to buy an equity at a pre-determined price, so it is an option to go long. In the fixed-income world the equivalent for swaps would be a receiver swaption, since it too is an option to go long the market. Receiver swaptions will tend to be at lower strikes than the current at-the-money level, since investors will not want miss out on a rally if it happens but are happy to pay less for an option that takes them long only after the market has moved up a bit.
Steepening and Flattening
Historical time series will confirm that the yield curve generally steepens in a rally and flattens in a sell off. This leads to terms like ‘bull steepening’ and ‘bear flattening’.
Here are a couple of mnemonics I invented which make it possible to quickly understand these terms:
steepening means the market is shortening its duration,
flattening means the market is lengthening its duration.
Let me give a short explanation. Over and above the usual reasons for why a steep yield curve is norm (compensation or risk premium for investing in longer-dated bonds), a steeper yield curve means that short-dated bonds are relatively more expensive than longer-dated bonds. This will be the case if:
- there have been more buyers of short-dated bonds than of longer-dated bonds, or
- there have been more sellers of longer-dated bonds than of shorter-dated bonds,
since both of these processes would push up the prices of shorter-dated bonds or push down the prices of longer-dated bonds.
But in both cases the ‘average’ portfolio has become relatively more short dated, and therefore has a shorter duration. The opposite holds for a flattening of the yield curve, of course.
So in summary we have two ways of steepening, and two ways of flattening, and these 4 possibilities give rise to all the bull/bear/flattening/steepening combinations:
- the market is buying short-dated bonds: bull steepening,
- the market is selling long-dated bonds: bear steepening,
- the market is selling short-dated bonds: bear flattening,
- the market is buying long-dated bonds: bull flattening.
Here is how it works in practice: you hear
“there was a bull steepening”
and the mnemonic immediately takes you to think:
“there was steepening, so duration is shortening”
and you know this could be either through the buying of shorter-dated bonds or the selling of longer-dated bonds. But the “bull” term tells you there was buying so you deduce:
“there was buying of short-dated bonds”
or in fancier terms:
“the short end rallied”.
Now that we have seen a few of the fundamental relationships in the fixed income markets, we move on to cover the main trader speak for buying and selling.
Actually, these jargon for buying or selling could be heard in any market and are really just terms for buying and selling of something.
(1): ‘hit’ and ‘lift’
Now that you have got the fundamental relationship under your belt, you need to get comfortable with the second level of jargon. The fact is that if you wander around a bond trading floor you are not likely to hear people say ‘I bought a bond’. Instead you’ll hear things like:
“I got hit at 93”,
“I lifted him before the rally”.
Seemingly mysterious, these terms are in fact a corollary of the most basic rules of trading:
if you buy then prices will move upwards,
if you sell then prices will move downwards.
It is only a simple step to now connect with the terms ‘hit’ and ‘lift’: if somebody somewhere buys an asset then its price will get lifted up; if somebody somewhere sells an asset then its price will get hit down.
So when a trader says “I just got lifted”, you know that someone has just bought from them:
I got lifted = somebody bought = I sold
I got hit = somebody sold = I bought
Similarly, a buyer would say “I lifted him at 100” to mean that they have just bought from a market maker and paid 100 for the asset.
Another couple of phrases you’ll regularly hear on the trading floor will now make sense to you:
“hit my bid”
“lift my offer”
(2): ‘mine’ and ‘yours’
These are a bit simpler: if I buy a bond I would say ‘it’s mine now’ and if I sell I would say ‘it’s yours now’.
There you go:
mine = I buy,
yours = I sell.
(3): ‘give’ and ‘take’
Similarly, if I sell you a bond I am giving it to you, and if I buy I am taking it from you:
I give = I sell,
I take = I buy.
The other form that is common is:
I got given = someone sold to me = I bought.
This is likely to be said more by a market maker who bought because someone hit their bid; it was passive buying.
Applying buy/sell language to swaps
When you enter into a swap, one party pays fixed and the other party pays a floating rate (usually a libor of some kind). The standard way to describe a swap transaction is to refer to the fixed-rate leg: eg
“I paid in 5 year” = I entered a spot-starting 5-year maturity swap in which I pay the fixed-rate leg and receive the libor leg.
At first sight it doesn’t seem appropriate to say that anyone is actually buying or selling anything, but the fact is that you will hear traders using buy/sell jargon for swap transactions too, so here we look at what it means.
The terminology follows from another simple principle of trading:
if you buy something and the price goes up you will have made money,
if you sell something and the price goes down then you will have made money,
and relies on interpreting the swap rate as a price of something. And what is the swap rate the price of?
The swap price principle: the swap rate is the price of the future libors.
So we have:
“buy the swap” = buy the libors = pay fixed,
“sell the swap” = sell the libors = receive fixed.
Here’s why this works. Suppose that the swap rate goes up and you had ‘bought the swap’, then you should now have registered a positive PnL on your swap position — which is the case if you were paying (fixed) in the swap.
All the other buy/sell jargon falls into place:
“mine” (for swaps) = I buy the swap = I pay fixed
“yours” (for swaps) = I sell the swap = I receive fixed
“I got hit” (for swaps) = I bought the swap = I pay fixed
“I got lifted” (for swaps) = I sold the swap = I receive fixed
“I got given” (for swaps) = I bought the swap = I pay fixed
The universal principle (full version)
Actually the logic behind this approach is very useful across the board and merits becoming our full version of the universal principle:
The universal principle: make everything a statement on prices.
Why? Because then you can apply the most basic rule of trading:
The key to everything: buy cheap and sell dear.
Here are the corollaries that we have effectively been using:
Corollary 1: in the world of rates we refer to the price of bonds.
Corollary 2: in the world of swaps we refer to the price of libors.
The principle can be applied to every trade you ever look at, and you should try to apply it to every trade you look at. For example:
- if you are pricing a steepener trade are you buying or selling the spread?
- if you are pricing an options trade are you buying or selling volatility?
- if you are pricing a rates trade are you long or short the market?
- if you price an asset swap are you buying or selling the basis?