Treasury Futures

Treasury futures contract is a financial debt instrument that allows the contract holder to buy or sell bonds on maturity at a predetermined price. It is a derivative contract popularly used in the United States. Its main purpose is to enable futures trading in bonds as well. 

The early origins of the treasury futures contracts date to the late 1970s. The Chicago Board of Trade, as a part of the Chicago Mercantile Exchange (CME) Group, started this trading in 1977. These futures include government bonds and notes, which are primarily available for future delivery. 

Treasury futures trading is a popular derivative instrument that acts similarly to any other futures contract. It allows traders to buy and sell bond contracts on a specific date, different from the actual maturity date. Thus, if a contract holder buys futures today, they may sell it after five years, which varies from the maturity date. However, these terms are decided at the time of future contract purchase.

The price of the U.S. treasury futures relies on the price of the underlying instrument. Here, the assets can be government bonds and notes utilized by the federal government to raise funds. Also, each contract has a tenure, coupon rate, margin (or minimum tick) and maturity date. Usually, the tenure of these contracts ranges from 2 years to 5 years, 10 years, and 30 years. However, the maturity of these contracts differs slightly.

For instance, the 2-year note has a maturity of 1 3/4 to 2 years. But, for a treasury bond, the maturity is 15 to 25 years. Likewise, the CME group has also launched Ultra 10-Year Note and Ultra T-Bond futures for smooth trading purposes. However, they can be exercised at 9 5/12 to 10 Years and 25 years to 30 years, respectively.

Furthermore, the futures contracts have a standardized face value of $100,000, except for 2 and 3-year contracts. They have a face value of around $200,000. Likewise, the closing position or expiry of the treasury futures occurs in quarterly cycles. It includes March, June, September, and December.

In order to conduct U.S. treasury futures trading, traders must follow a procedure slightly different from normal futures contracts. Let us understand them in detail:

• Choosing a Platform: Such trades are mostly traded on futures exchanges like CME and the Intercontinental Exchange (ICE). Traders such as asset managers, corporate treasurers, insurance companies, banks, mortgage bankers, pension funds, hedge funds, primary dealers, and proprietary traders have access to these futures. They can select the treasury type and maturity date. 
• Taking a Trade Position: The next step is to determine the trade position for these futures. Here, the trader may tend to choose a long position with the hope of rising bond prices. Likewise, a short position often leads to falling bond value. For instance, a trader may select 10 year treasury futures contracts. Later, choose the contract size and coupon rate. 
• Margin Requirements: Every trader must maintain a minimum tick or margin to facilitate such trade. For instance, the treasury bond futures value on the second day might have increased or decreased lately. As a result, the trader can add equivalent or more amounts to avoid uneven price movements. 
• Price Movements and Trade Amounts: The difference between contract value and current bond price determines the profit or loss received on any trade. The formula to calculate the profit is as follows;

Profit or Loss = Number of contracts* Change in price * $1000

• Settlement: The treasury futures contracts can be settled in two ways, either physical delivery or cash settlement. For government notes, delivery can occur on the last business day of the month. However, for bonds, the delivery may occur on any day of the contract month. 

Let us look at some examples of treasury futures to comprehend the concept better:

Example #1

Suppose Samuel is a trader who trades in mostly 10 year treasury futures. He believes the economy will perform better in the upcoming days. Also, the government is planning to increase the interest rates. As a result, Samuel decided to sell a futures contract. He bought a 5-year treasury bond with a face value of $100,000 in April 2024. At that time, the price was 120 30/32. Later, Samuel sold his 10 contracts at 120 25/30 after June 2028. Let us calculate the profit of this trade.

Profit = 10* (120 30/32 – 120 25/30)* $1000 = $1562.50

In this case, Samuel earned a profit of $1562.50 on the treasury bond futures contract purchased earlier.

Example #2

According to a news update as of December 2023, the CME Group has announced plans to expand the new suite of options on the treasury futures. In addition to the Wednesday and Friday expiry, traders can even exercise their contracts on Monday. The sole purpose of including this feature is to minimize risks around market-moving events. Plus, it also acts as a hedging tool across the yield curve.

In addition to its working, there are certain benefits of this derivative contract as well. Let us understand them in detail:

• It enables limited exposure to the treasury securities along with the features of futures contracts.
• Due to the volatile price movements, traders can easily book their profits from these trades. 
• With the help of interest rates, the futures contract value is quite predictable. 
• There is high liquidity available as they are easily accessible on certain stock exchanges.