Understanding trader jargon

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 wont 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 quants 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). its 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 well later see that buy/sell terminology is often also used for swaps (rather than pay/receive), and at that point well 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 wont 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 lets 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:

s teepening means the market is  s hortening its duration,

f l attening means the market is  l engthening 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:

1. there have been more buyers of short-dated bonds than of longer-dated bonds, or
2. 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:

1. the market is buying short-dated bonds:  bull steepening ,
2. the market is selling long-dated bonds:  bear steepening ,
3. the market is selling short-dated bonds:  bear flattening ,

4. 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.

Buy/sell jargon

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 .

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 youll 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 lift ed 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 youll 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 its mine now and if I sell I would say its yours now.