Yield futures ‒ Find answers to frequently asked questions

  • 13 Mar 2023
  • By CME Group

1. How are Yield futures different than existing Treasury futures?

While complementary to CME Group’s existing suite of Treasury futures, Yield futures feature an entirely new contract design intended to serve new use cases and provide market participants with an expanded set of trading and risk management capabilities for the U.S. government bond market. Yield futures are cash settled, traded in yield, and track a single on-the-run security ‒ whereas existing Treasury futures are physically delivered, traded in price, and track a basket of deliverable securities. Further, these products maintain a static basis point value of $10 across all tenors, making spread trading seamless and straightforward.

2. What is the difference between price and yield?

U.S. Treasury Notes and Bonds typically have a par amount (which is the dollar amount of the loan) and a coupon rate (which is the amount of interest paid to the lender twice a year). Over time, the consensus interest rate level might change while the coupon payments remain the same over the life of a note or bond. Therefore, if one were holding a Note and the prevailing interest rate went up while they were holding it, that Note would be worth less (the coupon interest payments would be less than the prevailing market interest rate). So, if they were to sell that note, the price they could command would decline. In this way, price and yield have an inverse relationship to one another. 

Put another way, the price is simply the price that one would pay for a note or bond and the yield is the interest the buyer would receive adjusted for the price and the coupon rate. These new contracts remove the need to convert a price to yield, which is the common metric quoted in most financial press outlets.

3. What does on-the-run mean?

The "on-the-run" security is defined as the most recently auctioned security. The U.S. Treasury maintains a set and published schedule of the days on which it will auction new Notes and Bonds for each tenor (years to maturity). For example, a new 5-Year Note will be auctioned on Wed, August 25, and so the “on-the-run” 5-Year will be this security until the Treasury issues a new 5-Year note on September 27. The on-the-run security is the most commonly-quoted yield on most financial news outlets.

4. The U.S. Treasury market is a very large debt market. How does CME Group determine the precise price/yield of the on-the-run security?

The Yield futures contract will track the BrokerTec U.S. Treasury Benchmark which will reflect the yield of the on-the-run security. The BrokerTec benchmark is sourced from transactions on the leading cash U.S. Treasury trading platform.

Because the 5-Year benchmark on the futures expiration day (end of the month) will reflect the yield of the on-the run security, when Yield futures begin trading on August 16, they will anticipate the upcoming auction (August 25), and therefore be available as a tool to manage the July-August cash roll. In other words, because the on-the-run security will change on August 25, the new futures contract will reflect yield of this new issue and provide the market with an indicative value for the July-August cash market roll.

5. What is the difference between cash settled and physically delivered?

  • Futures contracts that are cash settled (like the Yield futures) simply expire in a cash transaction on their expiration date and cease to exist. The holder of a cash-settled futures contract no longer has a position in the market after expiration.
  • Futures contracts that are physically delivered expire with an actual delivery of the physical commodity or financial instrument. For example, someone that held a long position in the current CME Group Treasury futures contracts until expiration would be obligated to take delivery of actual Treasury notes or bonds.

6. Why trade Yield futures?

Yield futures’ straightforward, yield-based design is both highly approachable and well suited to a variety of trading and risk management applications, including:

  • The U.S. Treasury securities market is, by many measures, the largest, most active debt market in the world. The U.S. risk-free interest rate impacts the prices of many different asset classes including equities, currencies, and commodities.
  • Gain exposure to on-the-run Treasury yields
  • Seamlessly execute DV01 neutral yield curve spreads
    • The DVO1 is defined as the dollar value of one basis point. These products are constructed such that each basis point (.01 of one percent) change in yield, represents a $10 move for each futures contract held. Because the “DVO1” is a static $10 AND consistent across the 2-,5-,10-, and 30-Year maturities, it makes trading Treasury spreads straightforward. 
  • Hedge Treasury auctions with greater precision
  • Trade the futures vs. cash basis via EFP (exchange for physical)

7. What is the relationship between Yield futures and the underlying on-the-run Treasury yield?

The relationship between Yield futures and the underlying on-the-run (OTR) Treasury yield depends on the direction of carry:

  1. If Total Carry > 0, then Yield futures > underlying yield
  2. If Total Carry < 0, then Yield futures < underlying yield.

Total Carry to Delivery represents the difference between the underlying on-the-run yield and financing cost (based on the term repo rate to delivery). Given this, case 1 is consistent with an upward-sloping yield curve where the on-the-run Treasury yield is greater than the shorter-term repo rate and case 2 is consistent with an inverted yield curve. To understand how this compares to “standard” Treasury futures, refer to FAQ #8 below.

Example: On 3/7/2023, the on-the-run 10-year U.S. Treasury note was the 3-½% of 3/2033. Furthermore, this Note remained the on-the-run 10-year note at expiration of the March 2023 10-year Yield futures contract. If there was a new on-the-run issue auctioned mid-month, this would need to be considered (as described in FAQ #9).

On the same day, overnight SOFR (as published by the Federal Reserve Bank of New York) was 4.55% and 1-month Term SOFR (as published by CME Group) was 4.73%. Given that the time to expiry of the futures contract is less than one month, the relevant term repo rate sits somewhere between overnight and 1-month Term SOFR. But 1-month Term SOFR is a close proxy for the term repo rate to expiry and unlike overnight SOFR, captures market expectations of the March FOMC decision (which can be tracked in the CME FedWatch Tool).

At 9:23am ET, the mid-yield for on-the-run 10-year note on BrokerTec was 3.957%. Since 4.73% (1-month CME Term SOFR) is greater than 3.957% (the on-the-run yield), total carry is negative. Given the relationship explained above, we would expect Yield futures to be priced lower than the underlying on-the-run yield of 3.957%. At the same time, the mid futures yield was 3.9405%, which was lower than the on-the-run yield, as expected.

8. How does the relationship between Yield futures and the underlying on-the-run yield compare with the relationship between Treasury futures and the underlying delivery basket?

Consider the theoretical relationship between Treasury futures prices and the cheapest-to-deliver (CTD) Treasury security:

Futures Price * CF = Bond Price – Total Carry to Delivery – Delivery Options Value

  • CF is the conversion factor
  • Bond Price is the price of the CTD Treasury security in the delivery basket
  • Total Carry to Delivery is the yield on the CTD less financing cost (based on the term repo rate to delivery)
  • Delivery Options Value represents the value of embedded physical delivery options held by the short.

Since Yield futures are cash-settled to the yield of a single Treasury security and do not have embedded delivery options, we will assume that the Conversion Factor = 1 and that the final term in the above equation is equal to zero:

Futures Price = Bond Price – Total Carry to Delivery

Given that carry is subtracted from the bond price to obtain the theoretical futures price, there are two possible cases for the relationship between the futures price and the CTD bond price:

1.    If Total Carry to Delivery > 0, then Futures Price < Bond Price

2.    If Total Carry to Delivery < 0, then Futures Price > Bond Price.

Case 1 is consistent with an upward-sloping yield curve where the longer-term Treasury yield is greater than the shorter-term repo rate. Case 2 is consistent with an inverted yield curve.

Given the negative relationship between price and yield, we expect the inverse of this relationship to hold between Yield futures and the underlying spot yield, consistent with the relationship outlined in FAQ #7.

9. What effect do U.S. Treasury auctions have on Yield futures?

An important aspect of Yield futures is that the on-the-run security may change during the life of the contract if a Treasury auction is held during the month. The futures yield will reflect this, meaning that the futures yield will reflect market expectations for the to-be-issued security, rather than that of the current on-the-run. The U.S. Treasury publishes and frequently updates a tentative auction schedule as a reference.

One advantage of this is that it gives traders the ability to trade the “when issued” (WI) Treasury weeks in advance, as demonstrated in this case study

10. How do publicly available yields published by the U.S. Treasury compare to the BrokerTec benchmark yields underlying Yield futures?

The U.S. Department of the Treasury calculates and publishes par yield curve rates (also known as constant maturity yields) that can be used as a proxy for BrokerTec benchmark yields. Historical time series are available through FRED and the U.S. Treasury.

However, there are some differences between constant maturity yields and the BrokerTec benchmark yields. The U.S. Treasury uses indicative bid quotes obtained by the Federal Reserve Bank of New York (FRBNY) at around 3:30pm ET and a bootstrapping method to derive its par yield curve. Constant maturity yields are taken from fixed points on this derived par yield curve (for more information, see Treasury Yield Curve Methodology). One implication is that constant maturity yields may not reflect actual market yields, while the BrokerTec benchmark yields are calculated using actual market yields from trades on the BrokerTec platform. Furthermore, BrokerTec benchmark yields are taken at 3pm ET, around 30 minutes before the FRBNY obtains its bid quotes that are used to derive constant maturity yields.

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