Beginner's Fundamental Questions

Discussion in 'Financial Futures' started by russia33, Sep 6, 2013.

  1. russia33


    I have been trading for a long time in equities and options but I am new to the futures world, particularly treasury bond futures which is what I am interested in learning. I have some questions which I have not been able to answer on my own.

    1. Why are the bid/ask spreads so high, and get higher the longer the date of delivery?

    2. Are treasury futures always cash settled or otherwise? Do any actual treasury bonds change hands in treasury markets as a result of futures contracts?

    3. To close out a treasury futures position, what happens exactly? What happens to the original contract price between buyer and seller as parties are interchanged?

    4. What are all of the carrying costs? Is the accrued coupon of the underlying treasury bonds taken in to calculation at any time? What is the cost of financing the leverage on the position? Are there any other additional costs to the aforementioned other than broker commission?

    5. Why is there a difference between initial margin and maintenance margin for futures contracts?

    6. If normal contango operating futures markets converge in to the spot price from a premium position to spot price is this not a seller advantaged market place?

    7. Is benchmark contract, 6%, $100,000 face value, applicable to all types of treasury futures?

    8. How do I compare a treasury futures price with the actual spot price of that treasury future adjusted for the benchmark contract?

    9. Because I have to deliver bonds from spot markets that are priced at a different par value than the benchmark contract does this mean I have to delivery odd and fractional lots of these securities?

    If anyone can help, I appreciate it.
  2. 1. Erm, "high" is probably a little too judgmental. Bid/ask is what it is. It gets wider with maturity because a) liquidity, arguably, gets worse; and b) duration of the contract gets bigger, which means you need to buy/sell fewer of them.

    2. Majority of treasury futures are physically settled, NOT cash-settled. Aussie bond futures are the only exception I know of. Treasury bonds can and often do change hands in the market as a result of the settling bond futures.

    3. What do you mean what happens? If you're short 10 lots and you want to close out, you buy back 10 lots at the offer price, et voila. The original trade where you sold them is irrelevant and I have no idea what you mean by interchanging parties.

    4. The carry costs are included in the price, as you're effectively trading a bond with a future delivery date. The accrued coupon is taken into account, indeed, and is "included" in the price. The cost of financing the leverage on this position is your personal cost of capital that you're required to post as margin. There should be no other explicit costs that I can think of.

    5. That's a question you can easily get an answer to in any textbook or on them intenets.

    6. In bond futures the terms "contango" and "backwardation" are not used. In general, yes, like in all other futures mkts, the price of the futures converges to the spot price. This isn't "advantageous" to anyone.

    7. No, it doesn't have to, although 6% and $100,000 is the most common. 2yr notes, for instance, are $200,000.

    8. You can't directly compare. What you can do is look at the forward yield (out of the delivery date) on the cheapest-to-deliver bond in the futures basket implied by the price of the futures contract.

    9. You have to deliver however much you have to deliver. Don't worry about "odd" or "fractional" lots of treasuries.

    Finally, I would strongly suggest you get your hands on Burghardt, Belton et al's book called "Treasury Bond Basis". It's the bible and it will answer all your questions.
  3. russia33


    Hey and thanks kindly for the reply martinghoul if I may follow up and clarify some things for myself about your response.

    1. With regards to spreads, perhaps I am seeing bad data but the spread on, for instance, ZF 5 year US March 2014 treasury note is wide to the point where initial entry on one contract results in an immediate spread deficit close-out of $4000 or so dollars. I don't know what the tick terminology equivalent is or what not. I just want to confirm if this is normal.

    2. With regards to physical settlement of treasuries: what are the mechanics of actually delivering these securities? How does one choose and facilitate the delivery process – via some broker instruction in some way? Does the buyer have any discretion over which of the eligible securities are to be delivered? Do most settlement transactions typically involve buyers holding the securities for a very short interval before selling them to market?

    3. With regards to closing a position my question is what happens to the contract obligation as parties are interchanged. Perhaps, I am somewhat naïve in my thinking but here is how I am picturing it from one perspective. In an options contract for instance between 2 parties, say a and B, an obligation price [strike price] and other terms are priced with a certain value. But, in a future’s contract the obligation price is also the price of entry, therefore in a future’s contract 2 parties are obligated in a manner that if I were to close out my position and interchange my role as party A in the contract with another party, say C, does this mean that party will C essentially enter under the same contract stipulation with party B as had been originally created? Does the difference in price then somehow go to me as a gain/loss? In an options contract everything is priced in to the options value and therefore parties can interchange with the terms of the contract remaining identical at all times. If I am not making sense, please disregard this question.

    4. A). Is it right to say that the accrued coupon is in essence included in the expectations of the spot price for treasuries in the future which will reflect the extra cost of coupon accrual in their respective delivery moment and the future’s price is the total obligation to be delivered having this adjustment already intrinsically a part of its price?

    B). As for margin financing rates for the treasury futures, is the leverage cost paid on margin that is used for the entire duration of having a position in the contract? Or, only when settlement is taking place? For instance when I sell put options I don’t pay any interest on my obligated purchase until or if I am exercised. Also, are these rates for financing treasury futures leverage referred to as “repo rates” in any way? How are these different from standard prime financing rates?

    8. I am not sure what you mean by looking at forward yield, how do you ascertain this? What do you mean by out of the delivery date? Can you provide a simple example?

    9. Is it possible to buy fractional lots in treasury markets?
  4. sle


    (1) No, it's not normal unless you are trading far-out contracts. In general, these are liquid in the front month or the second month, depending on the time to the delivery notice.

    (2) Yes, there is a delivery basket and the seller, obviously, wants to deliver the bond that is the cheapest at the time of delivery. The optionality in the delivery process (partially) drives the treasury futures basis. For more detail, see The Treasury Bond Basis or at least read the contract specifications. I can send you some JPM research on that, if you feel that you don't want to buy the book.

    (3) Erm...

    (4) I think you want to read about the delivery process a little bit more,d.eWU&cad=rja
  5. 1) Erm ...... you're thinking of what's known as the clearing corporation at the exchange. :p
    2) If you and I make a futures trade together, the "clearing corp" becomes the counterparty to each side of the trade after it "clears". You don't have to exit the trade with the same entity who you initiated the trade with :cool:
    3) If the market fluctuates in my favor and I offset the trade with a profit of $100, my profit comes from the debit to your account. I have a realized gain $100. You have an unrealized loss of $100. :D
    4) If I offset my trade with Martinghoul and then the market moves in your favor to have a gain of $200, Martinghoul would have an unrealized loss of $300 while you would have an unrealized gain of $200. :eek:
  6. 1. As sle mentioned, you should not be looking at the Mar14 contracts at this point. During the life of the quarterly trsy futures contract, liquidity normally exists only in the "front" contract. Currently, this is the Dec14 futures. When the "front" contract gets close to last trading day, liquidity and open interest migrates to the next quarterly maturity.

    2. The mechanics are tedious. Your broker has to have the facilities in place. As sle mentioned, a bond futures contract has a "deliverable basket" (a collection of bonds that are eligible), but, normally, at any one time there's a clear "cheapest-to-deliver" (CTD) bond. Delivering anything other than the CTD is, normally, uneconomic. As to what the buyer can do with the bonds after they get them, there's no "typical" behavior. People do whatever they feel like doing.

    3. As nazz mentioned, everything you do in trsy futures contract is done with the central counterparty (CME). This means that there's only ever A and B and never any C and everything you do is perfectly fungible.

    4A. You language is a little hard to understand, but yes, I think you got the right idea.

    4B. Everything that involves margins etc depends on your broker. And no, "repo rates" are something else entirely and are applicable to straight cash bond positions, rather than futures.

    8. Simplisitically, a trsy futures contract is an obligation to deliver a trsy bond at some point in time (contract delivery date). The current price of the futures contract contains all the information about the "expected" price of the trsy bond that will be delivered. Given you know the "expected" forward price, you can calculate the corresponding forward yield.

    9. I am not even sure what a "lot" means in treasuries. The minimum notional increment you can trade them in is $100, which is 1/1000th of a typical futures contract.

    At any rate, you should def read a book or two on this stuff.
  7. Typo in my previous post... Dec13, not Dec14 is the current front contract.
  8. 1) Besides the "full size" futures contract, i.e. "ZB", there might still be a half-size contract, i.e. "XB". It's liquidity is probably horrible. :(
    2) You may be better off with an ETF to trade instead if you are uncomfortable with the futures. :cool:
  9. russia33


    Thanks for all the responses, I will pursue further literature on the matter