Is there any downside to investing in bond futures?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
acegolfer
Posts: 1488
Joined: Tue Aug 25, 2009 9:40 am

Re: Is there any downside to investing in bond futures?

Post by acegolfer » Wed Jul 23, 2014 11:34 am

lee1026 wrote:
To see how big that difference is, consider buying the 4 year STRIPS, holding for a year, and then selling it as a 3 year STRIPS. The difference in price is 2.52%. You will have to buy very long yielding munis to have a comparable yield and open yourself up for far more interest rate risk.
How do you know what the 3yr strip price will be 1 yr from now? Its not going to be 2.52% higher.

Topic Author
lee1026
Posts: 394
Joined: Sat Jun 21, 2014 7:47 pm

Re: Is there any downside to investing in bond futures?

Post by lee1026 » Wed Jul 23, 2014 11:53 am

A long-term municipal bond fund, like a long-term Treasury bond fund, will sell bonds with durations much lower than its target and replace them with longer duration bonds.
Vanguard does not.
https://personal.vanguard.com/us/funds/ ... =INT#tab=2
How do you know what the 3yr strip price will be 1 yr from now? Its not going to be 2.52% higher.
I don't know what it is going to be, but I am counting on the fact that the yield curve is usually upwards sloping, and that inverted yield curves are fairly rare.

Tanelorn
Posts: 1642
Joined: Thu May 01, 2014 9:35 pm

Re: Is there any downside to investing in bond futures?

Post by Tanelorn » Wed Jul 23, 2014 12:06 pm

Thank you magician for correcting my math on the futures pricing.

More generally, would it be right to say that a fully collateralized position of rolling front month treasury futures, say 10 year ones, would approximate have the same interest rate risks and returns as a treasury bond fund with the same duration as whatever is typical of the 10 year cheapest to deliver treasury bond?

acegolfer
Posts: 1488
Joined: Tue Aug 25, 2009 9:40 am

Re: Is there any downside to investing in bond futures?

Post by acegolfer » Wed Jul 23, 2014 12:32 pm

lee1026 wrote: I don't know what it is going to be, but I am counting on the fact that the yield curve is usually upwards sloping, and that inverted yield curves are fairly rare.
Upward slope is irrelevant in your example. To make 2.52% gain as you predicted, you need assume the 3-yr zero rate will stay the same next year.

Topic Author
lee1026
Posts: 394
Joined: Sat Jun 21, 2014 7:47 pm

Re: Is there any downside to investing in bond futures?

Post by lee1026 » Wed Jul 23, 2014 12:40 pm

Sure, but "assume interest rates are unchanged" is part of any bond investment for anything but money market investments.

User avatar
magician
Posts: 1571
Joined: Mon May 02, 2011 1:08 am
Location: Yorba Linda, CA
Contact:

Re: Is there any downside to investing in bond futures?

Post by magician » Wed Jul 23, 2014 1:14 pm

Tanelorn wrote:Thank you magician for correcting my math on the futures pricing.

More generally, would it be right to say that a fully collateralized position of rolling front month treasury futures, say 10 year ones, would approximate have the same interest rate risks and returns as a treasury bond fund with the same duration as whatever is typical of the 10 year cheapest to deliver treasury bond?
Yup.

The downside would be all of the transaction costs every time you roll over the futures.
Simplify the complicated side; don't complify the simplicated side.

acegolfer
Posts: 1488
Joined: Tue Aug 25, 2009 9:40 am

Re: Is there any downside to investing in bond futures?

Post by acegolfer » Wed Jul 23, 2014 1:19 pm

lee1026 wrote:Sure, but "assume interest rates are unchanged" is part of any bond investment for anything but money market investments.
Any source to verify your statement?

Topic Author
lee1026
Posts: 394
Joined: Sat Jun 21, 2014 7:47 pm

Re: Is there any downside to investing in bond futures?

Post by lee1026 » Wed Jul 23, 2014 1:31 pm

Perhaps I was being a bit hasty there, but the risk of the interest rates shifting is always there for any bond investment, and that part is extremely well documented. But if we make the assumptions that none of us have a crystal ball with respect to interest rates, it makes sense to talk about two numbers - the return if interest rates do not change, and the amount that one would lose or gain if the interest rates shifted.

acegolfer
Posts: 1488
Joined: Tue Aug 25, 2009 9:40 am

Re: Is there any downside to investing in bond futures?

Post by acegolfer » Wed Jul 23, 2014 1:42 pm

lee1026 wrote:Perhaps I was being a bit hasty there, but the risk of the interest rates shifting is always there for any bond investment, and that part is extremely well documented. But if we make the assumptions that none of us have a crystal ball with respect to interest rates, it makes sense to talk about two numbers - the return if interest rates do not change, and the amount that one would lose or gain if the interest rates shifted.
And you ignored the 2nd part in your strategy. That is the interest rate risk, which is the fundamental risk of fixes income securities.

User avatar
Chan_va
Posts: 800
Joined: Wed Dec 05, 2012 7:15 pm

Re: Is there any downside to investing in bond futures?

Post by Chan_va » Wed Jul 23, 2014 2:19 pm

lee1026 wrote:Perhaps I was being a bit hasty there, but the risk of the interest rates shifting is always there for any bond investment, and that part is extremely well documented. But if we make the assumptions that none of us have a crystal ball with respect to interest rates, it makes sense to talk about two numbers - the return if interest rates do not change, and the amount that one would lose or gain if the interest rates shifted.
The phrase "Apart from that Mrs. Lincon, how was the play?" springs to mind.

User avatar
Kevin M
Posts: 11252
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Is there any downside to investing in bond futures?

Post by Kevin M » Wed Jul 23, 2014 2:25 pm

Fascinating topic. Seems a little too complicated for me these days, but I have been taking advantage of 5-year direct CDs as a superior alternative to 5-year treasuries (which as pointed out gives one the similar retail-investor-arbitrage benefit).

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

User avatar
Taylor Larimore
Advisory Board
Posts: 28827
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

A complex Wall Street creation. What to do?

Post by Taylor Larimore » Wed Jul 23, 2014 2:57 pm

"As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run." -- David Swensen, Yale Chief Investment Officer
"You shouldn't buy anything too complex to explain to the average 12-year old." -- Jane Bryant Quinn, Financial author and syndicated columnist.
Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

Johno
Posts: 1883
Joined: Sat May 24, 2014 4:14 pm

Re: Is there any downside to investing in bond futures?

Post by Johno » Wed Jul 23, 2014 3:07 pm

magician wrote:
Tanelorn wrote:Thank you magician for correcting my math on the futures pricing.

More generally, would it be right to say that a fully collateralized position of rolling front month treasury futures, say 10 year ones, would approximate have the same interest rate risks and returns as a treasury bond fund with the same duration as whatever is typical of the 10 year cheapest to deliver treasury bond?
Yup.

The downside would be all of the transaction costs every time you roll over the futures.
Which as described above comes to around 8bps pa. OTOH putting the 90% of the cash you'd need to buy the treasury, but don't need to support the futures position, into a bank account results in a pick up of around 60bps by doing it with futures/bank account rather than cash bonds. So the return is not the same, it's much better doing it with futures and bank account. But again to note, it's also much better doing it with a CD (and for the same underlying reason) though liquidity is more limited than futures/bank account option, and duration also more limited if you want long duration.
Last edited by Johno on Wed Jul 23, 2014 3:09 pm, edited 1 time in total.

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Bond futures -- A Wall Street creation. What to do?

Post by Beliavsky » Wed Jul 23, 2014 3:09 pm

Taylor Larimore wrote:
As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run. -- David Swensen, Yale Chief Investment Officer
Best wishes.
Taylor
Yale's endowment is not invested primarily in simple, passive, stock and bond investments:

http://investments.yale.edu/index.php/2 ... allocation
Over the past two decades, Yale dramatically reduced the Endowment's dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1993, just under half of the Endowment was committed to U.S. stocks, bonds, and cash. Today, domestic marketable securities account for approximately one-tenth of the portfolio, while foreign equity, private equity, absolute return strategies, and real assets represent nearly nine-tenths of the Endowment.

The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power. Today's actual and target portfolios have significantly higher expected returns and lower volatility than the 1993 portfolio. Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management. The Endowment's long time horizon is well suited to exploiting illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.

User avatar
Taylor Larimore
Advisory Board
Posts: 28827
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Yale's endowment and Vanguard's Balanced Index Fund

Post by Taylor Larimore » Wed Jul 23, 2014 3:35 pm

Taylor Larimore wrote:
As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run. -- David Swensen, Yale Chief Investment Officer
Beliavsky wrote:
Yale's endowment is not invested primarily in simple, passive, stock and bond investments.
Perhaps it should be. In 2013 Yale's Endowment generated a 12.5% return. Vanguard's Balanced Index Fund generated a 18.2% return.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

Johno
Posts: 1883
Joined: Sat May 24, 2014 4:14 pm

Re: A complex Wall Street creation. What to do?

Post by Johno » Wed Jul 23, 2014 3:36 pm

Taylor Larimore wrote:
"As a general rule of thumb, the more complexity that exists in a Wall Street creation, the faster and farther investors should run." -- David Swensen, Yale Chief Investment Officer
"You shouldn't buy anything too complex to explain to the average 12-year old." -- Jane Bryant Quinn, Financial author and syndicated columnist.
Best wishes.
Taylor
An investor shouldn't do anything he or she doesn't fully understand. That goes without saying IMO, but whether or not a 12 yr old understands it is irrelevant either way, with all due respect to Jane Bryant Quinn. And as the come back on Yale endowment illustrates, there's a valid distinction between doing more complicated things one understand, and buying 'Wall Street creations'. One year's returns certainly don't invalidate that general idea, but actually I don't know or care what the Yale endowment does relative to slightly complicated trades I might do that definitely work.

As far as how bond futures prices work relative to bonds that is a bit complicated but I haven't chimed in because it's not relevant to the individual investor. In that case you can be sure that professionals will arbitrage any but very small deviation in the price of the futures contract from the economics of buying the cheapest to deliver bond and financing it in the repo market (you should be aware which issue is CTD, even though you'd never take delivery, because tells you where you are on the yield curve by being long the contract, eg. the CTD for the 10 yr note contract in today's environment is generally a 7-8yr).

The thing the professional market *cannot* arb out is the difference between the repo rate and the similarly govt risk, ~0 duration maximum available FDIC insured retail bank account rate. Once more, a similar form of this arb, the essence of it, exists between CD's and treasuries, but futures might work better in certain cases based on liquidity, very long duration available (in the 'ultra' contract), and/or if one has limited room in tax deferred accounts. In such a case the IRA can be used to house the return from duration via futures, compactly, with only the zero duration (bank account) return subject to immediate tax outside the IRA.

Tanelorn
Posts: 1642
Joined: Thu May 01, 2014 9:35 pm

Re: Is there any downside to investing in bond futures?

Post by Tanelorn » Wed Jul 23, 2014 4:09 pm

Ok, here's a first crack at the math behind the advantages of bond futures over a bond fund. I'm using Johno's information on spreads and costs from earlier in this thread, and applying both the tax and collateral arbitrage effects to compute the net benefit. First, some assumptions:

33% Federal marginal income tax rate (interest and short term capital gains)
15% Long term capital gain tax rate
0% State tax rate
10% Futures collateral held (5-10x as much as minimum)
1% FDIC bank account interest (i.e. SFGI Direct or GE Bank)
0.09% annual costs for rolling futures quarterly ($62.5 in spreads, 4 round trips @ 1/2 tick each, $3.50/contract * 8 = $90.50)
0.25% risk free rate for futures

Now two benchmarks for the lazy, treasury bond investor:

1. Vanguards Intermediate Treasury Fund, Admiral Class
https://personal.vanguard.com/us/funds/ ... =INT#tab=0
ER: 0.12%
SEC yield: 1.63% (after expenses)
Duration: 5.2 years

2. Vanguards Long Term Treasury Fund, Admiral Class
https://personal.vanguard.com/us/funds/ ... IntExt=INT
ER: 0.12%
SEC yield: 3.09% (after expenses)
Duration: 16.2 years

Our lazy investor will get roughly the SEC yield (+- luck from market movements) on a pretax basis. After taxes at 33%, he would be left with 1.09% or 2.07% respectively for the intermediate and long term funds. How much better can he do with bond futures? For now, I will assume there exists a hypothetical bond future corresponding to the right duration of these funds so we can see the benefit without getting too deep into the logistics. First, let's get the pretax return of the futures investor:

Futures yield = SEC yield + fund ER (what the bond would earn) - risk free = 1.50% (Int) or 2.96% (Long)
Cash yield = FDIC rate * 90% (leaving 10% for futures collateral) = 0.90%
Pretax total yield = 2.31% (Int) or 3.77% (Long)
Post-tax total yield = 1.70% (Int) or 2.84% (Long), by applying the 60/40 rates to the futures and regular to the cash

This is 0.68% better than the bond versions in both cases on a pretax basis (due to the cash collateral arbitrage), and 0.61% (Int) or 0.77% (Long) better on an after-tax basis (due to the lower average tax rate on the futures yield). State taxes may complicate this, since treasuries are state tax exempt but capital gains from futures and bank interest are not. However, even with a 10% state tax, there was still about a 0.4% after-tax advantage to the bond futures.

I am not an expert on bond futures, so I would appreciate corrections of any errors or bad assumptions I may have made here. It does look like it should be possible to take the same risk as a treasury mutual fund while earning around 0.5% more. That's a big % given present interest rates!

User avatar
Chan_va
Posts: 800
Joined: Wed Dec 05, 2012 7:15 pm

Re: Is there any downside to investing in bond futures?

Post by Chan_va » Wed Jul 23, 2014 4:27 pm

Isn't this another variation on the "borrow short, lend long" strategy? You are comparing a 0 duration bond (FDIC savings acct) with a 5 year duration bond. All is well if the interest rates don't move, but what if they do?
Tanelorn wrote:Ok, here's a first crack at the math behind the advantages of bond futures over a bond fund. I'm using Johno's information on spreads and costs from earlier in this thread, and applying both the tax and collateral arbitrage effects to compute the net benefit. First, some assumptions:

33% Federal marginal income tax rate (interest and short term capital gains)
15% Long term capital gain tax rate
0% State tax rate
10% Futures collateral held (5-10x as much as minimum)
1% FDIC bank account interest (i.e. SFGI Direct or GE Bank)
0.09% annual costs for rolling futures quarterly ($62.5 in spreads, 4 round trips @ 1/2 tick each, $3.50/contract * 8 = $90.50)
0.25% risk free rate for futures

Now two benchmarks for the lazy, treasury bond investor:

1. Vanguards Intermediate Treasury Fund, Admiral Class
https://personal.vanguard.com/us/funds/ ... =INT#tab=0
ER: 0.12%
SEC yield: 1.63% (after expenses)
Duration: 5.2 years

2. Vanguards Long Term Treasury Fund, Admiral Class
https://personal.vanguard.com/us/funds/ ... IntExt=INT
ER: 0.12%
SEC yield: 3.09% (after expenses)
Duration: 16.2 years

Our lazy investor will get roughly the SEC yield (+- luck from market movements) on a pretax basis. After taxes at 33%, he would be left with 1.09% or 2.07% respectively for the intermediate and long term funds. How much better can he do with bond futures? For now, I will assume there exists a hypothetical bond future corresponding to the right duration of these funds so we can see the benefit without getting too deep into the logistics. First, let's get the pretax return of the futures investor:

Futures yield = SEC yield + fund ER (what the bond would earn) - risk free = 1.50% (Int) or 2.96% (Long)
Cash yield = FDIC rate * 90% (leaving 10% for futures collateral) = 0.90%
Pretax total yield = 2.31% (Int) or 3.77% (Long)
Post-tax total yield = 1.70% (Int) or 2.84% (Long), by applying the 60/40 rates to the futures and regular to the cash

This is 0.68% better than the bond versions in both cases on a pretax basis (due to the cash collateral arbitrage), and 0.61% (Int) or 0.77% (Long) better on an after-tax basis (due to the lower average tax rate on the futures yield). State taxes may complicate this, since treasuries are state tax exempt but capital gains from futures and bank interest are not. However, even with a 10% state tax, there was still about a 0.4% after-tax advantage to the bond futures.

I am not an expert on bond futures, so I would appreciate corrections of any errors or bad assumptions I may have made here. It does look like it should be possible to take the same risk as a treasury mutual fund while earning around 0.5% more. That's a big % given present interest rates!

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Is there any downside to investing in bond futures?

Post by Beliavsky » Wed Jul 23, 2014 4:42 pm

S&P has created bond futures indices that roll to the front-month contracts, as described in their publication "S&P Global Bond Futures Index Series Methodology", available online. With the ticker symbols in that report you can download historical data from Quandl from late 2008 on. So if someone wants to test long-only bond futures strategies, this is a way to start.

Tanelorn
Posts: 1642
Joined: Thu May 01, 2014 9:35 pm

Re: Is there any downside to investing in bond futures?

Post by Tanelorn » Wed Jul 23, 2014 6:10 pm

Chan_va wrote:Isn't this another variation on the "borrow short, lend long" strategy? You are comparing a 0 duration bond (FDIC savings acct) with a 5 year duration bond. All is well if the interest rates don't move, but what if they do?
No, it is not a borrowing trade - the advantages, as I laid out, come from both superior tax treatment and superior cash collateral returns available to individual investors via FDIC. The idea is that, up to a few adjustments (like costs), holding an appropriate bond future is the same as holding that bond. This is what I confirmed with magician a few post up (http://www.bogleheads.org/forum/viewtop ... 5#p2131026).

This means that you will get all the gains or losses of the bond fund, only via the future instead. That will be good if rate expectations fall, and bad if they rise. And you'll get an extra 0.50% after tax on top of whatever the bonds end up doing if you go the futures route (assuming I got my calculations right).

It's a little like owning a house. Even with a mortgage, you get all the gains or losses of the real estate market (barring default), from the time you buy until the time you sell. Futures let you get a lot of exposure with only a little capital, although you have to keep adding capital if the position moves against you or your broker will sell it.

Topic Author
lee1026
Posts: 394
Joined: Sat Jun 21, 2014 7:47 pm

Re: Is there any downside to investing in bond futures?

Post by lee1026 » Wed Jul 23, 2014 7:32 pm

And you ignored the 2nd part in your strategy. That is the interest rate risk, which is the fundamental risk of fixes income securities.
I did. I was comparing between rolling treasuries to buy a much longer dated muni fund. Rolling the 5 year treasury seems to offer around the same yield as the 20+ year CA tax exempt bond funds. As the 5 year treasury is a 5 year bond, it would be far less exposed to interest rate shifts relative to muni bonds. Same gains with lower risk seems like a win in my book.
"You shouldn't buy anything too complex to explain to the average 12-year old." -- Jane Bryant Quinn, Financial author and syndicated columnist.
Even stocks seem too complicated to explain to an average 12-year old, when you really get down into it. It is quite complex to explain the precise set of conditions under which a stock would lose or gain value. Bonds have the problem with interest rates and default risk. Simpler, but still somewhat complex, especially for anything other then a treasury. The only thing that I think I can explain to an 12 year old is a checking account, really.

User avatar
market timer
Posts: 6175
Joined: Tue Aug 21, 2007 1:42 am

Re: Is there any downside to investing in bond futures?

Post by market timer » Wed Jul 23, 2014 9:44 pm

lee1026 wrote:Perhaps I was being a bit hasty there, but the risk of the interest rates shifting is always there for any bond investment, and that part is extremely well documented. But if we make the assumptions that none of us have a crystal ball with respect to interest rates, it makes sense to talk about two numbers - the return if interest rates do not change, and the amount that one would lose or gain if the interest rates shifted.
You're describing roll down return, e.g., http://www.raymondjames.com/fixed_income_rolling.htm

User avatar
market timer
Posts: 6175
Joined: Tue Aug 21, 2007 1:42 am

Re: Is there any downside to investing in bond futures?

Post by market timer » Wed Jul 23, 2014 9:53 pm

Tanelorn wrote:I am not an expert on bond futures, so I would appreciate corrections of any errors or bad assumptions I may have made here. It does look like it should be possible to take the same risk as a treasury mutual fund while earning around 0.5% more. That's a big % given present interest rates!
Your numbers looks correct. It's important to note that your analysis does not depend on earning that SEC yield you have assumed as a return. Regardless of where interest rates go, the futures strategy outperforms the mutual fund strategy. If you have carryforward losses, the comparison is even more favorable.

Tanelorn
Posts: 1642
Joined: Thu May 01, 2014 9:35 pm

Re: Is there any downside to investing in bond futures?

Post by Tanelorn » Wed Jul 23, 2014 9:59 pm

market timer wrote:
Tanelorn wrote:I am not an expert on bond futures, so I would appreciate corrections of any errors or bad assumptions I may have made here. It does look like it should be possible to take the same risk as a treasury mutual fund while earning around 0.5% more. That's a big % given present interest rates!
Your numbers looks correct. It's important to note that your analysis does not depend on earning that SEC yield you have assumed as a return. Regardless of where interest rates go, the futures strategy outperforms the mutual fund strategy.
Yes, I was just using the SEC yield as the expected return for the base case. Certainly if bonds rise or fall, that will impact the tax calculations as well, but as you say the outperformance will be there from the collateral effect even if it just means you lost less than you would have otherwise.
If you have carryforward losses, the comparison is even more favorable.
Absolutely! Hopefully that will cease to be an issue for you soon :).

sawvp
Posts: 6
Joined: Sat Mar 09, 2019 2:53 pm

Re: Is there any downside to investing in bond futures?

Post by sawvp » Sat Mar 09, 2019 4:27 pm

I realize this post is far too old, but for those looking at it for information, it's worth noting that treasury futures behave differently than treasury etfs. They have bigger draw downs and don't perform nearly as well. I'm still trying to figure out why this is, but I'm guessing it has to do with the dividends. If you look, for instance on MacroTrends 2 year treasury futures, vs the performance of SHY, you'll see that SHY returns are much, much better than the futures.

acegolfer
Posts: 1488
Joined: Tue Aug 25, 2009 9:40 am

Re: Is there any downside to investing in bond futures?

Post by acegolfer » Sat Mar 09, 2019 6:11 pm

sawvp wrote:
Sat Mar 09, 2019 4:27 pm
I realize this post is far too old, but for those looking at it for information, it's worth noting that treasury futures behave differently than treasury etfs. They have bigger draw downs and don't perform nearly as well. I'm still trying to figure out why this is, but I'm guessing it has to do with the dividends. If you look, for instance on MacroTrends 2 year treasury futures, vs the performance of SHY, you'll see that SHY returns are much, much better than the futures.
Futures price is not the value of futures contract. Using it to compare against etf price is incorrect.

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Is there any downside to investing in bond futures?

Post by Beliavsky » Sun Mar 10, 2019 3:32 pm

sawvp wrote:
Sat Mar 09, 2019 4:27 pm
I realize this post is far too old, but for those looking at it for information, it's worth noting that treasury futures behave differently than treasury etfs. They have bigger draw downs and don't perform nearly as well.
If that were true, arbitrageurs would make money by buying Treasury bond ETFs and shorting Treasury bond futures. To compare Treasury bond futures returns with returns of Treasury bond ETFs you need to properly adjust for the rolling of futures contracts and add T-bill returns, since margin can be posted in the form of T-bills.

See the recent thread Understanding using treasury futures for leverage to implement risk parity where I discuss these issues.

sawvp
Posts: 6
Joined: Sat Mar 09, 2019 2:53 pm

Re: Is there any downside to investing in bond futures?

Post by sawvp » Mon Mar 11, 2019 2:32 pm

Beliavsky wrote:
Sun Mar 10, 2019 3:32 pm
If that were true, arbitrageurs would make money by buying Treasury bond ETFs and shorting Treasury bond futures. To compare Treasury bond futures returns with returns of Treasury bond ETFs you need to properly adjust for the rolling of futures contracts and add T-bill returns, since margin can be posted in the form of T-bills.

See the recent thread Understanding using treasury futures for leverage to implement risk parity where I discuss these issues.
Thank you so much Beliavisky! I was able to read through the thread along with some other valuable links provided in the thread itself. There's a nice link to S&P 2-Year U.S. Treasury Note Futures Index, which tracks funds that hold treasury futures. It shows an average of +1% a year for the past 10 years, which is consistent with SHY.

What I can't get my head around is the price I actually pay to buy and sell the futures contracts. I'm not sure if I can leave an outside link here, but you can see at Investors.com the "US 2 Year T-Note Futures". The current price is 106, which is the same price I can currently buy a contract for on Interactive Brokers. The price 10 years ago was 109, so I would have lost money had I continuously rolled the contract from 10 years ago.

This pricing data is consistent with what I see on MacroTrends as well. I guess I just don't understand how I somehow get around the price problem when buying a selling treasury futures.

I've purchased treasury futures in the past, and I have to buy and sell the contract for the going price. I know this for fact. I would really love to be wrong about this as I would far prefer to use futures rather than leveraged etfs, but I'm rattled by the numbers I see. I don't encouter this problem with the e-mini for example--the numbers track nicely, with futures returning slightly less than the sp500, but still right in the ballpark.

I see your point about the opportunity for shorting, which clearly must not really exist (great illustration btw--or you just discovered a great opportunity hehe). I hope I'm missing something, but whatever it is, it was not revealed in the link you so kindly provided.

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Is there any downside to investing in bond futures?

Post by Beliavsky » Mon Mar 11, 2019 4:20 pm

sawvp wrote:
Mon Mar 11, 2019 2:32 pm
Beliavsky wrote:
Sun Mar 10, 2019 3:32 pm
If that were true, arbitrageurs would make money by buying Treasury bond ETFs and shorting Treasury bond futures. To compare Treasury bond futures returns with returns of Treasury bond ETFs you need to properly adjust for the rolling of futures contracts and add T-bill returns, since margin can be posted in the form of T-bills.

See the recent thread Understanding using treasury futures for leverage to implement risk parity where I discuss these issues.
Thank you so much Beliavisky! I was able to read through the thread along with some other valuable links provided in the thread itself. There's a nice link to S&P 2-Year U.S. Treasury Note Futures Index, which tracks funds that hold treasury futures. It shows an average of +1% a year for the past 10 years, which is consistent with SHY.

What I can't get my head around is the price I actually pay to buy and sell the futures contracts. I'm not sure if I can leave an outside link here, but you can see at Investors.com the "US 2 Year T-Note Futures". The current price is 106, which is the same price I can currently buy a contract for on Interactive Brokers. The price 10 years ago was 109, so I would have lost money had I continuously rolled the contract from 10 years ago.

No, knowing that the current price is 106 vs. 109 10 years ago is not enough to tell you if a long position in 2-year note futures, rolled quarterly, had positive returns. You need to compute final_price - initial_price for each contract you would have owned and sum those differences. Two-year Treasury notes usually yield more than 90-day T-bills. Futures contracts on assets with such positive "carry" trade at a discount to the cash price of those assets. If you are long the futures contracts you benefit from that effect.

sawvp
Posts: 6
Joined: Sat Mar 09, 2019 2:53 pm

Re: Is there any downside to investing in bond futures?

Post by sawvp » Mon Mar 11, 2019 5:59 pm

I do see what you're saying. Now I'm trying to figure out a way to get this kind of data and test it myself...

sawvp
Posts: 6
Joined: Sat Mar 09, 2019 2:53 pm

Re: Is there any downside to investing in bond futures?

Post by sawvp » Mon Mar 11, 2019 6:24 pm

Beliavsky wrote:
Mon Mar 11, 2019 4:20 pm
sawvp wrote:
Mon Mar 11, 2019 2:32 pm
Beliavsky wrote:
Sun Mar 10, 2019 3:32 pm

No, knowing that the current price is 106 vs. 109 10 years ago is not enough to tell you if a long position in 2-year note futures, rolled quarterly, had positive returns. You need to compute final_price - initial_price for each contract you would have owned and sum those differences. Two-year Treasury notes usually yield more than 90-day T-bills. Futures contracts on assets with such positive "carry" trade at a discount to the cash price of those assets. If you are long the futures contracts you benefit from that effect.
On MacroTrends, they do say the prices are based on rolling them over--at least that's my understanding. Here's their quote:
Current and historical prices, chart and data for the CBOT 2-year US Treasury Note Futures #1 (TU1) contract. Contracts use the following methodology to allow long term price comparisons:

Front Month
Calendar-Weighted Adjusted Prices
Roll on First of Month
Continuous Contract History


Perhaps I'm misunderstanding the meaning of their explanation, but it's by far the only thing I can find online to describe what a continuous futures roll would look like. I'll post again if I find anything that might be useful to the other readers in terms of the individual contract returns that you mention above. Until then, I'm on the sidelines when it comes to treasury futures.

Thanks for all your participation in this discussion.

gtwhitegold
Posts: 436
Joined: Fri Sep 21, 2012 1:55 pm

Re: Is there any downside to investing in bond futures?

Post by gtwhitegold » Mon Mar 11, 2019 7:40 pm

Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?

User avatar
hdas
Posts: 1272
Joined: Thu Jun 11, 2015 8:24 am

Re: Is there any downside to investing in bond futures?

Post by hdas » Mon Mar 11, 2019 9:26 pm

gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

interestediniras
Posts: 82
Joined: Thu Jan 10, 2019 2:06 am

Re: Is there any downside to investing in bond futures?

Post by interestediniras » Mon Mar 11, 2019 9:48 pm

hdas wrote:
Mon Mar 11, 2019 9:26 pm
gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
Hi hdas: would you generally say it is safe to hold effectively 9x levered Treasuries through futures (with leverage factor determined by amount of collateral provided) with time-to-maturity of about 15 years? I am trying to figure out the best implementation of levered Treasuries, so sorry if this is a very naive question.

User avatar
hdas
Posts: 1272
Joined: Thu Jun 11, 2015 8:24 am

Re: Is there any downside to investing in bond futures?

Post by hdas » Mon Mar 11, 2019 9:59 pm

interestediniras wrote:
Mon Mar 11, 2019 9:48 pm
hdas wrote:
Mon Mar 11, 2019 9:26 pm
gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
Hi hdas: would you generally say it is safe to hold effectively 9x levered Treasuries through futures (with leverage factor determined by amount of collateral provided) with time-to-maturity of about 15 years? I am trying to figure out the best implementation of levered Treasuries, so sorry if this is a very naive question.
I’m not sure I understand exactly what you are trying to do, but that duration levered 9x can’t posibly be safe for buy and hold. Maybe you mean something else. Be mindful that with futures you have to adjust your leverage dynamically to maintain desired exposure.

What is your K?, What exposure you want?

Cheers
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

interestediniras
Posts: 82
Joined: Thu Jan 10, 2019 2:06 am

Re: Is there any downside to investing in bond futures?

Post by interestediniras » Mon Mar 11, 2019 10:24 pm

hdas wrote:
Mon Mar 11, 2019 9:59 pm
interestediniras wrote:
Mon Mar 11, 2019 9:48 pm
hdas wrote:
Mon Mar 11, 2019 9:26 pm
gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
Hi hdas: would you generally say it is safe to hold effectively 9x levered Treasuries through futures (with leverage factor determined by amount of collateral provided) with time-to-maturity of about 15 years? I am trying to figure out the best implementation of levered Treasuries, so sorry if this is a very naive question.
I’m not sure I understand exactly what you are trying to do, but that duration levered 9x can’t posibly be safe for buy and hold. Maybe you mean something else. Be mindful that with futures you have to adjust your leverage dynamically to maintain desired exposure.

What is your K?, What exposure you want?

Cheers
Yes, I think you're right. What about 3x-4.5x exposure for buy and hold, applied to a contract with underlying time to maturity of 10 years? Forgive the context-free nature of my questions, just trying to get some intuition for this space of possibilities.

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Is there any downside to investing in bond futures?

Post by Beliavsky » Tue Mar 12, 2019 7:13 am

hdas wrote:
Mon Mar 11, 2019 9:26 pm
gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
At IB your collateral can be cash, which they do pay interest on, currently 1.9% on balances exceeding $10K.

DonIce
Posts: 733
Joined: Thu Feb 21, 2019 6:44 pm

Re: Is there any downside to investing in bond futures?

Post by DonIce » Wed Mar 13, 2019 11:20 pm

sawvp wrote:
Mon Mar 11, 2019 5:59 pm
I do see what you're saying. Now I'm trying to figure out a way to get this kind of data and test it myself...
I was looking for the same in my thread that Beliavsky linked above. Never did find a good free source.

ThrustVectoring
Posts: 769
Joined: Wed Jul 12, 2017 2:51 pm

Re: Is there any downside to investing in bond futures?

Post by ThrustVectoring » Thu Mar 14, 2019 1:03 pm

Beliavsky wrote:
Tue Mar 12, 2019 7:13 am
hdas wrote:
Mon Mar 11, 2019 9:26 pm
gtwhitegold wrote:
Mon Mar 11, 2019 7:40 pm
Is what is acceptable for collateral only determined by the exchange, i.e. CBOE, or does the brokerage determine acceptable collateral?
For Tsy Futures would be CME....but yes it’s broker dependent, for instance IB requires 1 mill for using TBills as collateral....however most FCM’s would do it for any amount.

Cheers :greedy
At IB your collateral can be cash, which they do pay interest on, currently 1.9% on balances exceeding $10K.
Do you happen to know if IB nets out cash collateral in the futures account versus margin used in the brokerage account? Example:

Total Account Value: $10,000
Brokerage Account: $9000 equity, $1000 margin used
Futures Account: $1000 cash collateral for futures contracts

There's two different ways IB could calculate this: you either owe margin interest on $1000 or $0. If it's the latter, then you can effectively use the cash collateral in any way you want as long as you stay within IB's overall risk limits (which are way looser than you should ever go - it's essentially designed so that the worst-case daily move will exactly wipe out your entire position)
Current portfolio: 60% VTI / 40% VXUS

Beliavsky
Posts: 932
Joined: Sun Jun 29, 2014 10:21 am

Re: Is there any downside to investing in bond futures?

Post by Beliavsky » Thu Mar 14, 2019 2:54 pm

ThrustVectoring wrote:
Thu Mar 14, 2019 1:03 pm
Do you happen to know if IB nets out cash collateral in the futures account versus margin used in the brokerage account? Example:

Total Account Value: $10,000
Brokerage Account: $9000 equity, $1000 margin used
Futures Account: $1000 cash collateral for futures contracts

There's two different ways IB could calculate this: you either owe margin interest on $1000 or $0. If it's the latter, then you can effectively use the cash collateral in any way you want as long as you stay within IB's overall risk limits (which are way looser than you should ever go - it's essentially designed so that the worst-case daily move will exactly wipe out your entire position)
I think it's the latter. The only time I have paid margin interest at IB have been when the value of my securities positions have exceeded my account equity, regardless of what futures positions I have on.

IB has test accounts you could use to answer your question, and people at the Elite Trader forum could answer it more definitively.

Post Reply