Client:
Retail/self-directed traders
Challenge:
Individual investors are used to viewing U.S. Treasury rates in yield terms. Some of them may have been discouraged from participating in trading the standard U.S. Treasury futures, because they are traded in price terms.
Solution:
Yield futures
Overview
The U.S. Treasury market is the largest interest rate market in the world. As of 2020, the total outstanding amount of Treasury debt was nearly $21 trillion.1 Many global rates are pegged to U.S. Treasury maturities, including many consumer rates like mortgages.
Historically trading changes in the yield on U.S. Treasuries was reserved for dealers and large commercial institutions. Yield futures from CME Group are a new product, based on the yields of benchmark 2-, 5-, 10-, and 30-year Treasury securities scaled in size to the self-directed retail trader.
Simple in their design, the futures contacts are cash settled and trade in yield rather than price terms and have a common DV01 of $10 per contract maturity. The minimum price change increment is 1/10 of a basis point equal to $1 per contract.
Trading Illustration
Many economic indicators can influence the yields of U.S. Treasury securities. One that is monitored by rates traders every month is the U.S. Employment Report usually released the first Friday morning of every month. For illustrative purposes consider the August 2021 reporting period. Note this example is not based on actual futures contract trading data but reflects actual yield levels from reliable third party, publicly available sources.
On August 4 ‒ in advance of Friday’s Employment Report ‒ a trader believes the non-farm payroll (NFP) will show higher than expected employment given credence to a stronger economic outlook for the U.S. economy. A stronger economy may lead to higher 10-year Treasury yields. This trader buys the 10-Year Yield (10Y) contract for August expiration at a yield of 1.150, representing a 1.150% yield in the current on-the-run (OTR) U.S. Treasury 10-year note.
On August 6, the NFP Report is released and is higher than most market consensus estimates and the yield on the U.S. Treasury OTR 10-Year note goes up to 1.280%. This trader takes advantage of the uptick in yield to lock-in a profitable trade by selling the long 10Y position at 1.280.
Trading Example
The difference between the initial long (buy) position and the offsetting short (sell) position was 1.280 – 1.150 = 13.0 basis points, or 130 1/10 (minimum price increments). Each minimum price increment is worth $1 ‒ 130 x $1 = $130 profit on the trade. It should be noted that rates could easily have gone the other way, resulting in a possible loss in the trade.
Be advised that just like all CME Group futures contracts, Yield futures require initial, maintenance, and variation margin. For the 10Y contract referenced above the initial margin is roughly $190 per contract.2
Notes
- Data source, SIFMA, sifma.org, July 2021
- CME margins subject to change. Consult your broker for latest margins and collateral requirements umber
Conclusion
The U.S. Treasury market is the largest interest rate market in the world. New Yield futures from CME Group provide access to benchmark maturity points along the yield curve based on actual OTR Treasury yield levels in futures contracts sized to an individual, self-directed trader’s risk tolerance.
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