Micro sized exposure to US Treasury yields
The new contracts will be launched by CME on August 16 2021 and will be based on the “on-the-run” yields, i.e. the yields of the most recently auctioned Treasury securities, at four key tenor points across the curve (2Y Note, 5Y Note, 10Y Note and 30Y Bond).
The contract size is just $10 per each basis point of Treasury yield (i.e. 0.01%). If, for example, the 30Y Treasury Yield is 2%, the contract value will be $2,000.
Is this a totally new contract and was it really needed?
The answer to this question is definitely yes. The new micro Treasury Yield futures are indeed a new type of contract and, given the micro size, they will be useful in providing easier access to the Treasury (yield) future market.
Investors can already trade very liquid US Treasury futures, like the 10Y T-Note, the Ultra 10Y T-Note, the T-Bond, the Ultra T-Bond, etc. but these contracts have a face value of $100,000 with prices quoted in points per $1000.
As an example, a Ultra Treasury Bond future with a price of 188’300 will have an exposure of more than $188,000.
Clearly these micro Treasury Yield Futures will be much more accessible to the average investor.
But what makes these contracts somehow new is the fact that they are traded in yield terms and refer to a single on-the-run security. On the other hand, Treasury futures are traded in price terms and refer to a basket of underlying bonds (with maturity range depending on the tenor of the future contract).
Another difference, that is less important for most, is the fact that the new contract will be cash-settled.
Can this replace TLT (or TMF) in Trading Mate’s strategies?
Our strategy is using TLT (or TMF for leveraged exposure). TLT is a liquid ETF which holds bonds in the long-end of the Treasury curve thus providing an easy way to gain long-term Treasury exposure.
The chart below shows the results of our strategy applied to TLT trading. Current exposure can be accessed here.
The natural question one might have is whether it is possible to replace TLT with the new Treasury Yield futures. The best proxy that will be offered is the 30Y Yield future as it covers the long-end of the curve. For the reasons summarised above, the TLT is not expected to track exactly the 30Y yields but it will be close enough to be considered as a proxy. The example below shows the TLT price and the inverse of the 30Y yield (in orange).
So, should we use the new micro futures in our strategy we would need to find the equivalent number of futures to use to get the desired exposure. At current levels, 100 units of TLT give the investor a sensitivity of $26.3 for each 1bps move in the underlying yields. Given the new future (in this case 30Y) has a sensitivity of $10 per bps, that implies that to replicate a 100 TLT exposure we would need to use 2.6 future contracts (to be rounded to the nearest inteteger, so in this case 3). With these quantities, for a given bps move in the yield, the two positions will generate a similar P&L. Why similar and not exactly the same? One reason is discussed in the next section.
Some technicality to keep in mind
The TLT sensitivity is not constant but will change as the underlying yields change. This is because the underlying bonds have convexity and this implies that if the yields move a lot, the sensitivity we have calculated when entering the trade might change significanlty thus making the replication via Yield futures less effective.
This is not a major issue in short term trading but can become a factor if the position is held for long period of time. So if that is the case, it is important to regularly recalculate the TLT sensitivity to adjust the quantity of futures to hold in order to replicate the desired exposure.
Conclusions
The launch of these new contracts is definitely positive for those who want to have an almost 24h access to the US Treasury market but don’t want to have the large exposures offered by the existing futures.
As such, using these new futures to replace TLT or TMF in our strategies is a good option for those who prefer to trade futures and be able to close at any time of the day. Hedging existing TLT exposures while the cash market is close will also be made easier with these new contracts.
One simply has to calculate the number of futures to hedge the existing exposure and make sure this is rebalanced in case the yields have moved a lot.