10 yr cash bonds vs. bond futures

N

newbunch

I have noticed that while the 10-year cash bonds and bond futures move together, for some reason the bond future is a lot less volatile. On Thursday, cash bonds were down 18/32 while bond futures were down 10.5/32. On Wednesday (from memory), cash was down 13/32 while futures were down 10/32. For the last week, cash bonds were down 0.57% (my system records the %age moves and not the number of ticks) and futures were down 0.40%.

I've noticed this for a while and haven't been able to figure it out. It looks like the futures move 70% of the cash bond move. Anybody know why?
 
It probably has mostly to do with the coupon yield of each instrument. The futures are based on a 6% coupon. The most recently issued 10-year note is ~5%. Lower coupon secuities are more volatile in order to equalize their total return compared to that of the futures contract.
 
What is a good source of information in order to understand all the factors that effect the bond basis....does anyone have any trading tips on this type of trade!!!!
 
The cheapest to deliver bond matures on 2/15/13 and havs a effective duration of 5.5

10 year cash on the run bond matures on 2/15/16 and has an effective duration of 7.4

For a same interest rate movement, the bond with longer duration has a bigger price movement.
 
Here's what I found:

"Currently, bond futures trade in price terms. The short chooses which of several deliverable bonds to deliver, and receives for it a price of the EDSP (the Exchange Delivery Settlement Price, the final price of the future) times the conversion factor for that bond, plus the accrued. The effect is that, often, one bond is far cheaper to deliver than any other. If the contract is above par this is the shortest bond; if below par, the longest. In either case the lone cheapest-to-deliver (CTD) is vulnerable to being squeezed."

Which means, if bond yields are below 6% (the standard), the shorts will deliver the shortest dated cash bonds they can (bonds with 6.5 years to maturity). If yields are over 6%, they'll deliver the longest dated cash bonds (the most recent issued 10 year, which is almost always 10 years to maturity). Since yields are currently below 6%, bond futures are not actually based on the 10 year bond, but on the 6.5 year bond, which makes bond futures move 69% as much as the cash bonds (darn close to my 70% estimate). You can determine the relative move by determining the duration of the 6.5yr and 10yr bonds.

I'm just surprised this isn't more publicly known and clearly put on the CBOT website.
 
Anyone who trades cash bonds is intimately familiar with these concepts. The reason the CBOT doesn't talk about this more is probably that all cash traders look at this relationship (called the "basis") but only a subset of futures traders care about basis. In addition, basis affects the cash much more than the futures due to the ability of dealers and hedgies to manipulate the cash side of the equation.

That being said, in trading ignorance is never bliss. Read The Treasury Bond Basis by Galen Burghardt. If you can replicate the calculations in the book in Excel or with code you will understand this relationship.
 
Thank for the help …and I will follow your advice and get the Treasury bond basis book! i've been trading the basis for some time but have never shared or discussed my trade with a basis trader ......i would really like to have a chat with anyone who does what i do!!!!! :)
 
The difference between cash and future makes a difference in my trading. In fact, it should make a difference for anybody who long term trades the future.
 
I should add that I am not really trading the 10-year bond future. I really trade the 10-yr interest rate (TNX) and execute those trades with the future. Therefore, the duration of the CTD affects my exposure to the change in the TNX.

I hope that makes sense. It makes sense to me, I just don't know if I explained it clearly.
 
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