Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

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Kevin M
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Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

I posted this in another thread in the investing and theory board, but maybe it will get more responses on this board.

Summary: The cost to sell the Jan 2023 and buy the Jul 2023 in terms of bid/ask yield is 98 basis points (78 of which is due to the Jan 2023 sale), and the seasonally-adjusted (SA) yield pickup is 2.62 percentage points, so net SA yield gain is 164 basis points. This seems like it makes sense. Details are quoted below.

I'd appreciate input from anyone who actually buys and sells TIPS or other Treasuries, or anyone else who can point out any flaws in my analysis.

Thanks,

Kevin
Kevin M wrote: Tue Nov 22, 2022 4:30 pm
Kevin M wrote: Mon Nov 21, 2022 9:16 pm <snip>
I would not buy the Jan 2023 now, which means I should consider selling what I own and buying a longer maturity. I'll think some more about that tomorrow.
<snip>
OK, I've done some analysis, and here's what I come up with. First, I own 100 of the Jan 2023, so I would get the best sell price (min qty 100), and I would get the best ask price for the replacement, which would be either the Apr or Jul 2023.

First I looked at it using quoted prices and yields:

Image

The net price bid/ask is 23 to 24 basis points, but I think the yield bid minus ask is more relevant for making the decision.

For the Jan 23 -> Apr 23, the total of the two bid/ask spreads is 1.09%, and the incremental yield pickup is 1.61%, so I would come out ahead I think. From the quoted yields, it appears that the Jan 23 -> Jul 23 does not come out ahead by as much.

Next, I calculated the seasonally-adjusted (SA) yields, and get this:

Image

So using SA yields, the Jan 23 -> Jul 23 has a net yield gain of 1.64% (= 2.62% - 0.98%), vs. 0.87% for Jan 23 -> Apr 23.

So it looks like selling the Jan 23 and buying the Jul 23 is the better swap, but I'd appreciate any comments before I pull the trigger on this. This is in an IRA, so no tax consequences.

Thanks,

Kevin
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by retired@50 »

I figured #Cruncher would have responded by now...

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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

^Me too! Hopefully he's diligently crunching the numbers, and will get back to us soon. ;-)

305 views and no replies!

I guess I don't have to do this swap today. Hopefully will get some inputs in the next few days.

One thought occurred to me: maybe I should only be including half of the bid/ask spread as the cost for each transaction, assuming that the midpoint is what one would get if this were an auction purchase. This makes this an even more attractive swap.
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

What I have in mind is to do an internal rate of return (IRR) analysis, assuming some level of inflation from 12/1/2022 to maturity. #Cruncher is better at this than I am, but if I take a stab at it and share it here, he'll probably correct any mistakes I make.
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by retired@50 »

Kevin M wrote: Wed Nov 23, 2022 12:54 pm ^Me too!
You could always try a private message, just to see if #Cruncher is awake...

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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

retired@50 wrote: Wed Nov 23, 2022 2:11 pm
Kevin M wrote: Wed Nov 23, 2022 12:54 pm ^Me too!
You could always try a private message, just to see if #Cruncher is awake...

Regards,
Did that already last night.
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

I've started working on the IRR analysis. It's more complicated for TIPS, since you need to use index ratios to calculate the nominal cash flows.

One thing I've realized is that we can't know the price of the Jul 2023 TIPS on 1/15/2023 when the Jan 2023 matures, so we can't establish a nominal value for the Jul 2023 on that date. Instead, I assume I'll put the proceeds from the Jan 2023 TIPS into a money market fund and keep it there until the Jul 2023 TIPS matures, at which point I know the price is 100.

I also need to make an assumption of how much of the bid/ask spread to include in valuing the net cash flow on the settlement date of the swap. All of it, or half of it? And I must determine which price to use in valuing the Jan 2023 on the hypothetical settlement date if I were to hold it: average of ask and bid?

I've made progress, but haven't yet accounted for accrued interest, so that's next.

Kevin
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

The problem with doing the analysis to 7/15/2023 is that the result depends a lot on the inflation assumptions from 1/15/2023 to 7/15/2023. I really want to figure out a sensible way to do it till 1/15/2023. Now I'm thinking I should just accrue the market discount from settlement to 1/15/2023, and use that as the 1/15/2023 price for the Jul 2023 TIPS. I'll try that next. I think accruing the market discount makes sense, since that would result in a price of 100 at maturity.
Last edited by Kevin M on Wed Nov 23, 2022 10:30 pm, edited 1 time in total.
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

OK, here are my XIRR analysis results:

Image

In column F are the cash flows assuming I hold $100 face value of the Jan 2023 TIPS, and in column G are the cash flows assuming I sell $100 face value of the Jan 2023 and buy $100 face value of the Jul 2024.

In general, I use the average of the bid and ask prices as the value if I'm not selling or buying. For example, to value the Jan 2023 TIPS on the hypothetical settlement date in column F, I use the average of the settlement date bid and ask prices, then add the accrued interest as of settlement. All real values are multiplied by the index ratio for that TIPS on the date of interest.

If I'm selling I use the bid price, and if buying use the ask price. I add one half of the bid/ask spread multiplied by the Jan 2023 TIPS index ratio on settlement date to the cost to purchase the Jul 2023 (cell G2).

Unless I've made some mistakes or bad assumptions, the IRR analysis does not support doing this swap, which is not the conclusion I come to if just looking at the yields and bid/ask yield spreads.

Here are the formulas for the XIRR calculations:

Image

Thinking about this, it seems that if there were an opportunity to capitalize on this swap, that it would be arbitraged away, which is what the IRR analysis supports. Trying to reconcile the IRR analysis with the yield gain and yield spreads analysis.

#Cruncher, where are you?

Kevin
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by #Cruncher »

Kevin M wrote: Tue Nov 22, 2022 6:32 pmI'd appreciate input from anyone who actually buys and sells TIPS or other Treasuries, or anyone else who can point out any flaws in my analysis.
Kevin M wrote: Tue Nov 22, 2022 4:30 pm... I own 100 of the Jan 2023, so I would get the best sell price (min qty 100), and I would get the best ask price for the replacement, which would be either the Apr or Jul 2023.
...
So it looks like selling the Jan 23 and buying the Jul 23 is the better swap, but I'd appreciate any comments before I pull the trigger on this.
(underline added)
First off, I don't fit the underlined portion of the description above. I'm not a TIPS trader. In my IRA I only buy a new TIPS at auction every year or two to maintain a 10-year rolling ladder. In my taxable accounts I haven't bought a TIPS in the secondary market since 2008 or at auction since 2014. As each one matures, I roll the proceeds into a TIPS fund to simplify income tax reporting.

Secondly, while I appreciate all the useful work Kevin has done in his Trading Treasuries (nominal and TIPS) thread, trading short term TIPS doesn't interest (pardon the pun) me. I generally trust the market to price TIPS appropriately taking into account the fact that TIPS are indexed to a non-seasonally adjusted CPI. I would simply pick the maturity that matched my plan, ignoring yield differences to nearby maturities.

But it's apparent Kevin gets a kick out of making these decisions, so let me try to contribute something to the discussion.
  • It's important to properly frame the choice. I try to make the alternatives have the same start and end point. For example, here is one possible framing: Setting the start and end points to today and January 15, 2023, do either ...
    • Alternative 1: Sell Jan 2023 today and roll proceeds into the July 2023.
    • Alternative 2: Hold Jan 2023 until maturity and then use proceeds to buy the July 2023 at that time.
  • The better alternative will be the one that produces the most value of the July 2023 as of 1/15/2023.
  • Inflation is irrelevant in this choice. You'd be investing the same amount in TIPS of one maturity or the other either way; and they'd both receive the same inflation adjustment.
  • I believe the main determinant would be the July 2023's yield on January 15th. If it's below a certain value on that date, it would have been better to do the exchange now.
  • Below is a table that attempts to compare the alternatives:
    • Rows 10-17 show alternative # 1 where the Jan 2023 is sold now and all the proceeds used to purchase the July 2023.
      • Row 15 shows that for each $1,000 of principal of the Jan 2023, we could buy $1,007.87 of principal of the July 2023.
      • Row 17 shows that with the Jan 15 interest payment this would grow to $1,009.76 on 1/15/2023.
    • Rows 18-25 show alternative # 2 where we wait until its redemption to exchange the January 2023's proceeds into the July 2023.
      • Row 21 shows that the January 2023 will redeem for $1,000.63 including the final interest payment.
      • On row 22 we postulate that the July 2023's yield will be 2.205% on that date.
      • Row 24 shows that this means each $1,000 of principal will cost $990.95.
      • Row 25 shows that, with this cost, we would get $1,009.76 of principal in exchange for the Jan 2023 proceeds. This matches the value we'd have if we'd made the exchange now (on row 17).
      • If the July 2023's yield is lower than 2.205% on 1/15/2023, then it would be better to buy now. If it is higher, then it would be better to wait.

Code: Select all

Row                               Col A       Col B       Col C
  2                           Principal       1,000
  3                          Settlement  11/23/2022
  4                            Maturity   1/15/2023   7/15/2023
  5                              Coupon      0.125%      0.375%
  6                Previous coupon date   7/15/2022   7/15/2022  =COUPPCD($B3,B4,2,1)
  7                    Next coupon date   1/15/2023   1/15/2023  =COUPNCD($B3,B4,2,1)
  8                      Days in period         184         184  =B7-B6
  9               Days until settlement         131         131  =$B3-B6

Code: Select all

 10  If Jan 23 exchanged for Jul 23 now            
 11                               Price      99.798      98.929
 12                               Yield      1.530%      2.057%  =YIELD($B3,B4,B5,B11,100,2,1)
 13                    Accrued interest        0.44        1.33  =$B2*(B5/2)*(B9/B8)
 14                          Total cost      998.42      990.62  =$B2*(B11/100)+B13
 15                 Principal purchased                1,007.87  =B2*(B14/C14)
 16                    Interest 1/15/23                    1.89  =C15*(C5/2)
 17    Value 1/15/23 if bought 11/23/22                1,009.76  =C15+C16

Code: Select all

 18        If Jan 23 held to redemption            
 19                               Price     100.000
 20                    Interest 1/15/23        0.63              =B2*(B5/2)
 21           Total value at redemption    1,000.63              =B2+B20
 22            Assumed yield on 1/15/23                  2.205%
 23                 Corresponding price                  99.095  =PRICE(B4,C4,C5,C22,100,2,1)
 24                          Total cost                  990.95  =B2*(C23/100)
 25                 Principal purchased                1,009.76  =B2*(B21/C24)
The above analysis is probably overly complicated, and I'm not even sure it's valid. But I hope it helps with Kevin's decision.
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Re: Should I sell Jan 2023 TIPS and buy Jul 2023 TIPS?

Post by Kevin M »

#Cruncher wrote: Thu Nov 24, 2022 8:16 am First off, I don't fit the underlined portion of the description above. I'm not a TIPS trader. In my IRA I only buy a new TIPS at auction every year or two to maintain a 10-year rolling ladder. In my taxable accounts I haven't bought a TIPS in the secondary market since 2008 or at auction since 2014. As each one matures, I roll the proceeds into a TIPS fund to simplify income tax reporting.

Secondly, while I appreciate all the useful work Kevin has done in his Trading Treasuries (nominal and TIPS) thread, trading short term TIPS doesn't interest (pardon the pun) me. I generally trust the market to price TIPS appropriately taking into account the fact that TIPS are indexed to a non-seasonally adjusted CPI. I would simply pick the maturity that matched my plan, ignoring yield differences to nearby maturities.
Given this, it's even more amazing that you are so generous with your time in doing this type of analysis for me and others who can use #crunching help.

Note that despite his lack of interest in trading short-term TIPS, #Cruncher was a significant contributor some years ago to our understanding of seasonal adjustments, which are relevant mostly to shorter-term TIPS.

Thanks for the analysis. I wanted to use 1/15/2023 as the end date. I'm not sure what I'd do when the Jan 2023 TIPS mature, which is maybe another reason not to do the swap.

Your conclusion that it depends on the July TIPS yield on Jan 15 seems to mirror my observation that it depends on the July TIPS price on Jan 15. I used initial price plus accrued market discount as an estimate of the price on Jan 15, which corresponds to a yield of 1.96%.

I'm still curious about my own analyses, for which I ended up with opposite conclusions from the two methods.

At any rate, since I want to be able to roll the Jan 2023 TIPS into some unknown maturity TIPS on Jan 15, I will hold to maturity. Another observation is that the Jan 2023 TIPS was the largest single holding in Vanguard short-term TIPS fund, VAIPX, as of 10/31/2022.

Image

If there were some expected benefit in selling the Jan 2023 TIPS to buy a different maturity, I assume that Vanguard would have done so.

Thanks!

Kevin
If I make a calculation error, #Cruncher probably will let me know.
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