Does the fact that you can use other bond positions to be long the futures (and roll over the contracts) add to long-term returns ? I'm trying to figure out the best choice for maximizing returns. for ex: if you put your money in 1-3 year USTs and long the 10y USTs futures, compared to being outright long 10y UST bonds. Are you going to have extra returns with the former? In theory it should pay 0.5% more per year (yield minus libor financing)
You're mixing apples and oranges comparing 1-3 year cash bonds with a 10 year future; since the difference in yield between 1 year and 10 year will be quite significant. The 10 year will have a higher return but also more risk (higher duration). Assuming what you really want to do is compare holding a 10 year cash bond with the 10 year future (or 2 year versus 2 year, and so on): - You will effectively pay LIBOR to fund the future, wheras buying the bond is fr. However you're giving up an opportunity cost - the yield you'd get on the cash if you haven't bought the bond. Perhaps a better comparision is buying the bond on repo, or with margin. Which is best depends on whether you can get LIBOR risk free on your cash - most people can't so the funding you get when you are long the future is very cheap. - You have to roll the future every 3 months; but then you'd also have to roll the 10 year bond or it would age and become a 9.5 year bond, then a 9 year bond and so on. Of course you might not want to roll, but if it's exposure to 10 year yields you want you ought to roll. The future will probably be cheaper to roll, at least for a retail trader. - You will get hit by MTM on the future, but not on the cash bond, again unless you buy it on margin or repo. - With the future you're getting the yield on the cheapest to deliver; you could hold a slightly different 10 year bond if you wanted. The difference will be small; a few basis points. - Commissions and spreads will be different. The future is probably cheaper. GAT