The construction of the AIR TRF futures was created with an embedded floating rate to offer an economic return profile more analogous to a traditional equity swap. This can help investors who wish to manage longer dated equity exposures without the complication of pricing in dividend risk or trading fixed-rate financing. AIR TRFs also provide a transparent view of the equity financing level of a given index for different maturities along the curve. A full explanation of AIR TRF that describes the interest rate profile, day counts, accruals, financing, and other calculations is provided here.

The S&P 500 AIR TRF was first launched in September 2020 and CME Group has recently expanded the suite to include the five key U.S. equity indices.

Investors have noted that the liquidity and margin efficiencies of total return futures often make the product a popular alternative to Total Return Swaps (TRS). Uncleared Margin Rules (UMR) have been a significant driver of this adoption and have resulted in initial margins on bilateral equity index swaps rising to a minimum of 19% versus exchange-traded margins, which are typically in the 4-5% range (AIR TRF margins discussed below). ¹

With a centrally cleared futures contract, there are additional features beyond margin savings. Trading total return futures enables one to net down offsetting margin across all counterparties that one may face.  Another advantage is being able to seek transactional liquidity from multiple counterparties rather than being tied to the original liquidity provider as in the case of a swap.

Trading various maturities via AIR TRF calendar spread (e.g., Short 1Y vs. Long 4Y) can offer supplementary alpha opportunities by isolating equity index financing in certain parts of the maturity profile. This benefits from significant margin efficiencies and potentially higher returns on capital deployed.

As a reminder, AIR TRFs are traded in terms of a basis points spread to the Overnight Effective Federal Funds Rate (EFFR). This financing spread is known as the Total Return futures spread level (TRF spread level) and is traded via the BTIC² mechanism available at CME Group.

Clients are using AIR TRFs to trade the equity financing curve by trading calendar spreads. By trading a calendar spread, many of the underlying components that make up an AIR TRF cancel out, and one is left with the financing spread adjustment of one maturity contract vs. the financing spread adjustment of another contract. At Exhibit 2 below, the offsetting nature of the product characteristics are explored to explain how the financing spreads can be isolated.

The price of an AIR TRF is defined as:

Where:

Expanding the funding financing spread adjustment FSA_t, one can see the time to expiry (T_t) and the spread price (S_t) are unique to each maturity.

Where:

The example is continued to consider a calendar spread position, whereby an investor is long the December 2025 S&P 500 AIR TRF against a short December 2022 S&P 500 AIR TRF. The notation is like the above formula, but specific maturity dates are added for the additional clarity.

Terms cancel out, leaving one Financing Spread Adjustment less another: 

The formula above demonstrates that when one executes an AIR TRF calendar spread trade, the resultant risk at inception is the isolated financing rate of the period between the maturities of the calendar spread legs. While the overlapping period of the front and back legs will have different traded funding spreads as a function of the maturity of each leg, they are subject to the same daily equity financing rate on each day thereafter. Therefore, the traded risk variable is the isolated equity financing spread for the non-overlapping period of the calendar spread. 

Thus, the net exposure of the above example is that one is long the equity financing exposure on the S&P 500 Total Return Index between Dec 22 and Dec 25. This highlights that isolating the TRF spread levels via a calendar spread in AIR TRFs makes the equity financing trade very transparent and effective. The fact that the financing levels for each leg of the trade are quoted in terms of a basis point spread to the underlying interest rate, is similar to the market practice of how swaps are quoted. This helps provide a degree of familiarity and intuitiveness to trading the product.

In addition, due to margin offsets between the legs of a calendar spread, the ratio of capital deployed to notional exposure is very low. This means relatively small shifts in the equity financing curve can result in meaningful alpha-generating opportunities. This can be seen in the real-world example outlined further below in this paper.

The S&P 500 AIR TRF was launched in September 2020 and has seen significant demand. Barely into its second year, OI has grown to 170,000 contracts (around $40 billion notional). There is material interest out to the December 2028 contract, currently the most distant contract listed. Contracts are listed quarterly (Mar, Jun, Sep, Dec) for 13 consecutive quarters and four additional December contracts thereafter.

Much of the open interest is concentrated in the December contracts and is relatively evenly spread along the maturity profile in those December contracts. Liquidity is present along the curve and regularly trades in clip sizes of 1,000 to 2,000 contracts (equivalent to $250-500 million notional). This means that in addition to all the valuable features that AIR TRFs offer, investors can now manage total return exposures in a liquid manner, out to seven years in the future.

Different periods in time frequently have different financing requirements and those levels can change at one point of the curve independently of the other. In 2021, there was significant movement of all the TRF spread levels for the S&P 500 AIR TRFs.  Earlier in the year, the deferred contracts moved to higher TRF spread levels whilst the front maturity contracts were relatively static. Later in the year, the volatility of the front contracts’ TRF spread levels was much higher relative to the deferred contracts (see Exhibit 4). 

These variations in equity financing levels at different maturities, can result in trading opportunities which can be enacted by implementing a calendar spread position in AIR TRFs. This is because the calendar spread explicitly isolates the financing spread differential for the non-overlapping period whilst the spot index exposure and daily accrual is equal and opposite for the overlapping period and are thus nullified.

Given a view, investors can trade nearby contracts or even more distant calendar spreads. This includes using the quarterly contracts to trade intra-year calendar spreads, or even using the December contracts to trade longer-dated spread differentials. There are a lot of potential opportunities.

With so many trading opportunities and strategies, it is also important to understand the cost of the trade.  Here, AIR TRFs are highly competitive with affordable margin costs.

AIR TRFs are capital efficient when trading outright positions, however the margin efficiencies become even more significant when trading a calendar spread, given much of the underlying risk offsets.

The initial margin as of March 4, 2022 was $12,540 or 5.5 %.

For a calendar spread the initial margin required is $935 or 0.41%.³

Given the capital efficient nature of the calendar spread trades, an investor who has additional capacity in the portfolio; perhaps freed up by using outright future positions to invest in the index in lieu of cash or being long cash via dividend income, can potentially generate further alpha by putting such portfolio cash balances to work by taking views on the equity financing curve.

One example whereby trading a calendar spread in AIR TRF resulted in an alpha generation opportunity was in early January 2021. From January 15^th until January 22^nd, the TRF spread price moved lower for the December 2022 contract, while the TRF spread price for the December 2025 contract moved higher.  The corresponding AIR TRF futures values moved as a result and are provided in Exhibit 5.

Exhibit 5 calculates both the net change in TRF Spread levels and the associated net change in AIR TRF prices and displays the overall gain for a hypothetical calendar spread trade in 1,000 contracts per leg, whereby the investor went long the December 2025 contract and short the December 2022 contract.

One can see that the TRF Spread level of the December 2022 contract changed in favor of the short position by moving from 45 to 41 basis points, while concurrently the TRF Spread level on the December 2025 position moved from 49.5 to 54.5 basis points in favor of the long position. Those changes in TRF Spread levels and the resultant futures price changes, led to a net price change of 6.9 index points on the calendar spread position in favor of the long position (-Dec 2022 + Dec 2025). Given the contract multiplier is $25 this means the calendar spread has changed in value by +$172 (6.9 index points x $25) and that the total position value increased by $172,000.

In this example the return on capital deployed was 18.4% achieved over a one week holding period.  This example demonstrates that changes in the shape of the equity financing curve provide tactical trading opportunities that can be realized over a short holding period. AIR TRFs allow clients to implement trades to specifically isolate and trade these equity financing levels at different points along the maturity profile while requiring relatively low amounts of capital).

The AIR TRF complex continues to see grow in volumes and open interest. Given the raft of incoming macro events and potential impacts to equity indices, dividends and interest rates, the total return index space should be interesting to watch and trade.

For those clients interested in trading equity financing levels, calendar spreads on AIR TRFs provide a transparent and capital efficient trading solution by allowing investors to explicitly isolate the financing spread differential for the non-overlapping period.

At the start of 2022, clients are embracing the product at an accelerating rate (with the ADV up over 100% vs FY 2021) and we look forward to seeing AIR TRFs reach new heights in 2022 and beyond.⁴

1. In December 2021 the Standard Initial Margin Model (SIMM) increased to a minimum of 19% (vs 15% prior) for non-cleared Developed Market Equity Index Swaps.
2. BTIC stands for Basis Trade at Index Close and more information can be found here
3. Source CME: Margins levels are subject to change. Current margin levels can be found here. It is worth noting initial margin levels are 10% higher than maintenance margins.
4. 2022 ADV through to the end of February was 3,854 contracts - source CME.