CTD Bond Futures Question

I understand the concept of CTD that includes the conversion factor, invoice price, choosing bonds in the delivery basket and etc... but why does the futures contract track the price of CTD treasury bonds? I understand this is relatively important to gain insights on relative value, so any explanation would help? Thanks.

I'm in NYC and I met a bond trader from the street at a bar and he told me he trade less liquid off the run bonds and non-CTD bonds? Why would he trade such instrument? I didn't have a chance to ask him so any insights would appreciative.

Comments (20)

Best Response
Dec 26, 2017 - 8:46pm
  1. Only one bond can be delivered into the futures at expiry, and the CTD is the most economically efficient bond for the short to buy.

1a. The CTD is the bond with highest implied repo rate, which is the theoretical return from buying the cash bond/selling futures against it

  1. Real money accounts (Insurance, pensions, etc) have long term investment horizons, and may hold bonds for a long time. If they want to sell "old" bonds, some off the run trader will make a market
Dec 26, 2017 - 10:18pm

the CTD bond tends to trade with a consistently tight basis market in the broker screens...and combined with a tight market for the bond future...the price of the CTD bond is therefor easily "known" (with a 1 tick bid/offer spread)...whereas other bonds often do not have a tight basis market...which lends to wider bid/offer spreads...and hence better chance to make money on a relative value trade...and less liquidity = higher chance that a small trade will move the market for an off the run bond "more" than it should, providing those relative value opportunities.

just google it...you're welcome
  • 3
Dec 27, 2017 - 2:26am

Also CTD bonds have the lowest Basis Net of Carry ie delivery option value. BNOC basically is a measure of richness of a bond vs it's futures. Thus the contract seller will deliver the bond with the lowest BNOC.

"The markets are always changing , and they are always the same."
  • 1
Dec 28, 2017 - 7:22pm
JoyfulMonkey:

Also CTD bonds have the lowest Basis Net of Carry ie delivery option value. BNOC basically is a measure of richness of a bond vs it's futures. Thus the contract seller will deliver the bond with the lowest BNOC.

while this is "true"...it has nothing to do with how to make trading decisions regarding rich/cheap. its like saying "the P/E ratio for this stock is 20% higher than the P/E ratio for this other stock in the same industry." Doesn't tell you what the trade is...maybe useful information...but not the deciding factor in trade analysis.

just google it...you're welcome
  • 2
Dec 29, 2017 - 4:03am

SB'd you.

Thanks for helping me understand :).

Could you also explain how exactly would this information be useful in trading?

"The markets are always changing , and they are always the same."
Dec 29, 2017 - 4:04am

Cheapest-To-Deliver Bond Futures (Originally Posted: 08/23/2012)

So it is said that when bond yields are in excess of 6%, the conversion factor system tends to favor low-coupon long-maturity bonds; when yields are less than 6%, the system tends to favor delivery of high-coupon short-maturity bonds.

Can someone explain why? Thanks.

Dec 27, 2017 - 10:43am
mswoonc:

why does the futures contract track the price of CTD treasury bonds? I understand this is relatively important to gain insights on relative value, so any explanation would help? Thanks.

its actually the other way around...the CTD bond tracks the bond future via the basis (tho...you could argue it either way, since they are essentially "substitutes" for each other). There is no liquid outright market for the CTD bond...but there is a liquid outright market for the bond futures. Then there is usually a tight basis (spread) market for the CTD bond to swap it for the future. So, if you want to buy a CTD bond, the most economically efficient way is usually to buy the futures contract, and then buy the basis (buy the bond/sell the future). Non-CTD bonds will usually trade with a wider basis (wider spread), And since non-CTD bonds are not tied to the futures contract, they can wiggle around a little without the market giving it to much care. This is where RV traders can make a little $$.

There are over 300 treasury coupon securities...but only the 6 on the runs and the futures contracts trade in a liquid outright market. Everything else is mostly traded on spread (and so the bid offer spread on those spread securities tend to be wider that the bid offer spread for the benchmarks). The dealers charge a premium for taking this spread risk....that is the wider bid/offer spread. The less liquid an issue, the wider the spread. This is true in any market...and the treasury market is no different.

just google it...you're welcome
  • 3
Dec 27, 2017 - 11:18pm

Does anyone really make money trading off the runs anymore? QE ate up a lot of the supply. I've heard it's been a bad market for brokers in that space and haven't heard of much action in the off-the-runs.

But the basics of what you say are correct.

Besides QE. Reg T and high margin requirements killed a lot of players in that space. Maybe some big boys still earn decent returns there.

Dec 28, 2017 - 11:45am

my garban broker told me that lots of guys make 5-10mm trading off-the-run spreads...so depending on your AUM size...thats either a lot, or a little

just google it...you're welcome
Dec 29, 2017 - 4:05am

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