Long Forward Rate Agreement, short Eurodollar futures

For this question

If you are long a FRA and short a ED future with the same fixing dates, do you have positive convexity or negative convexity?

The answer is positive convexity, because a Eurodollar future has no convexity and the FRA has positive convexity. What are the implications of this from a trading perspective? Specifically, under what conditions does this lead to an opportunity for arbitrage?

Answer

hypothetically if we assume that $R_{fra}=R_{fut}-\frac{1}{2} \cdot \sigma^2\cdot T^2$ holds (convexity adjustment) and you are able to observe $R_{fra}$, $R_{fut}$ and $T$ then you can extract implied volatility of reference interest rate. If your view on volatility is different then you can make a bet: long convexity position (if you expect volatility should be higher); or short convexity position (if you expect volatility should be lower).