macrocephalopod on Twitter: "Because the aum tracking the index got so large, this created a predictable and sizable flow in commodity futures spread contracts which you could get ahead of. The strategy was to put on the same spread that the dealers would need to do, five days before they"

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

People love positioning/flow arbs on this site (dealer option hedging, target vol and risk parity flows, convexity hedging etc etc, all the same shit with different names) so let me tell you about the **greatest flow arb that ever existed**

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

The strategy had double digit return and high Sharpe for about eight years from 2000-2008, with a kicker that let you continue running it until ~2014 if you were crafty

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

First you need to know about the GSCI -- the Goldman Sachs Commodity Index. It was created by GS in 1997 to track passive long exposure to commodity markets. Crucially it is an *investable index* which means that you can replicate its returns by trading in liquid instruments,

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

in this case commodity futures. GS fully laid out the methodology for calculating the index and how to replicate it by trading in futures, which meant that dealers were able to sell swaps on the index and pull in a nice fee, which they started doing in size.

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

The index is now administered by S&P and you can find the full methodology here. Apart from some tweaks to the exact commodities included and their weights, it is exactly the same as it was in 1997 https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-gsci.pdf …

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

The key that makes the trade possible is to replicate the index dealers need to hold near-term futures and roll them to a later expiry before they become due. The index methodology lays out the exact schedule of rolls for every commodity, including which contract months will

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

be held, and which days they will be rolled on -- in basically every case the roll takes place over five days, with 20% of each position being rolled before the close on the 5th, 6th, 7th, 8th and 9th and ninth business days of the month.

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macrocephalopod‏ @macrocephalopod 22 Feb 2021

Because the aum tracking the index got so large, this created a predictable and sizable flow in commodity futures spread contracts which you could get ahead of. The strategy was to put on the same spread that the dealers would need to do, five days before they

8:21 AM - 22 Feb 2021