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 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).
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: