Tools
Recent Electronic
CBOT Contract Changes Spell New Trading Opportunities
Amplifying 8% to 6% Implications
Delivery Eligibility of Reopened U.S. Treasury Bonds and Notes
Amplifying 8% to 6% Implications
Delivery Eligibility of Reopened U.S. Treasury Bonds and Notes
Calls
Daily Vol
6% Coupon Change FAQ
On February 22, 1999, the Board of Directors of the Chicago Board of Trade voted to change the nominal coupon for all of the fixed-income contracts from 8% to 6%, beginning with the March 2000 contracts.* Also, the deliverable basket of securities for the 5-year note will increase due to the addition of one security.* Following are the most frequently asked questions and answers about the changes to the Treasury Complex and the Municipal bond futures contract.
Q. Why change the Treasury futures contracts?
A. Currently, the CBOT Treasury contracts tend to represent single issues of very short duration rather than issues more nearly representative of the deliverable baskets. This could continue well into the year 2001 unless yields rise sharply. Under current conditions, a yield move to levels above 7% would be necessary for the contract to again become representative of the general Treasury market. This change in notional coupon will ensure that the futures contracts (1) trade at or near par value and reduce abnormal price distortion in the cheapest-to-deliver (CTD) cash issues from which the futures contracts derive and (2) optimize the contracts' embedded delivery options and encourage increased participation by basis and relative value traders. In general terms, Treasury futures contracts currently exhibit lower embedded optionality, shorter duration, and a higher liquidity premium in the underlying CTD cash instrument while incurring increased potential for instances of delivery shortages. These coupon changes promise to alleviate any such difficulties.
Q. What will happen to Treasury futures prices?
A. Futures prices will be lower. With the notional coupon closer to current yields, the contract will price closer to par because of the higher conversion factors. Historically (1980-1999), the 8% bond futures contract price has ranged from about 55 to about 135. However, the calculated theoretical price for the proposed 6% bond futures contract during the same period ranged from 45 to 110.
Q. How will the change in the coupon influence cheapest-to-deliver status? A. The CTD bond will change more frequently. A single issue will always be CTD, as before, but no one bond or note is likely to become as firmly entrenched as has been the recent case. With the new notional coupon, there will be many more bonds within two basis points of the cheapest to deliver (increasing the quality and timing options of the contract). In this case, the market will price the futures contract to the basket of bonds. The bond basis will be driven by a basket of bonds, rather than a single entrenched issue, which stabilizes the basis relationship between futures and cash. Without changing the notional coupon to 6%, the contract will continue to track one issue with unique characteristics.
Q. What will happen to the conversion factors? A. Conversion factors will be higher. Beginning with the March 2000 contract, the conversion factors will be calculated at the hypothetical price at which each bond or note would yield 6% as of its maturity on the first delivery day of a contract month. The CBOT will distribute conversion factor tables in the near future.
Q. What will happen to Treasury futures calendar spreads?
A. The Dec 99-Mar 00 Treasury bond calendar spread could be 18 to 20 full points compared to current spreads around 16/32. Upon expiration of the December 1999 contract, the calendar spreads will be affected primarily by the lower level of futures prices and the higher value of the delivery options.
Q. Will a change in the coupon affect the volatility of the options on Treasury futures?
A. The implied volatility of Treasury options is expected to increase, for any given level of yield volatility, due to the relatively higher modified duration of the cheapest-to- deliver bond.
Q. Will a change in the coupon affect the dollar volatility of the bond and note contracts?
A. The higher conversion factors associated with a 6% notional coupon will reduce the converted dollar values of basis points for the bond and note contracts. But the change in coupon will cause the contracts to track longer duration securities to somewhat offset this effect.
For the 5-year and 2-year contracts, the change in coupon should not have a dramatic affect on which securities will be cheapest to deliver. The addition of a lower duration security to the 5-year deliverable basket means both the 5-year and 2-year note futures contracts will have slightly lower volatilities.
Q. How will the change effect hedge ratios? A. Hedge ratios will be larger. The flip side of lower dollar volatility is higher hedge ratios. The less price volatility the contract exhibits, the greater the number of contracts needed to hedge a position and vice versa. By some estimates, the new conversion factors will lower dollar values of basis points by roughly 20% and, as a result, lead to all hedge ratios being about 20% higher.
Q. Will the change in the coupon alter the duration of the bond contract?
A. Yes, durations will be longer.
The CTD bond will tend to have a higher modified duration at a given yield level, because the CTD issue will have a longer maturity and lower coupon. The increase in the duration alleviates the growing concern among hedgers that the current bond futures contract may be a less representative hedging vehicle for their cash market positions.
Q. Why was the delivery window of the 5-year contract changed, and what is the benefit of doing so? A. The purpose of this change is to increase the size of the deliverable basket.
When the U.S. Treasury switched from a monthly to a quarterly auction for U.S. 5-year T-notes in July of 1998, the number of issues eligible for delivery into the 5-year futures contract declined from as many as eight to only three. By allowing issues with a remaining maturity of 4 years, 2 months to be eligible for delivery, the CBOT will make one additional issue eligible for delivery each quarter. This will reduce the potential for squeezes and provide cash traders additional basis trading opportunities.
*Pending CFTC approval
For more information, call:
Cynthia Williams
312-435-7216
Nancy Kaplan
312-347-3808
Thomas Cosgrove
312-347-3823
Q. Why change the Treasury futures contracts?
A. Currently, the CBOT Treasury contracts tend to represent single issues of very short duration rather than issues more nearly representative of the deliverable baskets. This could continue well into the year 2001 unless yields rise sharply. Under current conditions, a yield move to levels above 7% would be necessary for the contract to again become representative of the general Treasury market. This change in notional coupon will ensure that the futures contracts (1) trade at or near par value and reduce abnormal price distortion in the cheapest-to-deliver (CTD) cash issues from which the futures contracts derive and (2) optimize the contracts' embedded delivery options and encourage increased participation by basis and relative value traders. In general terms, Treasury futures contracts currently exhibit lower embedded optionality, shorter duration, and a higher liquidity premium in the underlying CTD cash instrument while incurring increased potential for instances of delivery shortages. These coupon changes promise to alleviate any such difficulties.
Q. What will happen to Treasury futures prices?
A. Futures prices will be lower. With the notional coupon closer to current yields, the contract will price closer to par because of the higher conversion factors. Historically (1980-1999), the 8% bond futures contract price has ranged from about 55 to about 135. However, the calculated theoretical price for the proposed 6% bond futures contract during the same period ranged from 45 to 110.
Q. How will the change in the coupon influence cheapest-to-deliver status? A. The CTD bond will change more frequently. A single issue will always be CTD, as before, but no one bond or note is likely to become as firmly entrenched as has been the recent case. With the new notional coupon, there will be many more bonds within two basis points of the cheapest to deliver (increasing the quality and timing options of the contract). In this case, the market will price the futures contract to the basket of bonds. The bond basis will be driven by a basket of bonds, rather than a single entrenched issue, which stabilizes the basis relationship between futures and cash. Without changing the notional coupon to 6%, the contract will continue to track one issue with unique characteristics.
Q. What will happen to the conversion factors? A. Conversion factors will be higher. Beginning with the March 2000 contract, the conversion factors will be calculated at the hypothetical price at which each bond or note would yield 6% as of its maturity on the first delivery day of a contract month. The CBOT will distribute conversion factor tables in the near future.
Q. What will happen to Treasury futures calendar spreads?
A. The Dec 99-Mar 00 Treasury bond calendar spread could be 18 to 20 full points compared to current spreads around 16/32. Upon expiration of the December 1999 contract, the calendar spreads will be affected primarily by the lower level of futures prices and the higher value of the delivery options.
Q. Will a change in the coupon affect the volatility of the options on Treasury futures?
A. The implied volatility of Treasury options is expected to increase, for any given level of yield volatility, due to the relatively higher modified duration of the cheapest-to- deliver bond.
Q. Will a change in the coupon affect the dollar volatility of the bond and note contracts?
A. The higher conversion factors associated with a 6% notional coupon will reduce the converted dollar values of basis points for the bond and note contracts. But the change in coupon will cause the contracts to track longer duration securities to somewhat offset this effect.
For the 5-year and 2-year contracts, the change in coupon should not have a dramatic affect on which securities will be cheapest to deliver. The addition of a lower duration security to the 5-year deliverable basket means both the 5-year and 2-year note futures contracts will have slightly lower volatilities.
Q. How will the change effect hedge ratios? A. Hedge ratios will be larger. The flip side of lower dollar volatility is higher hedge ratios. The less price volatility the contract exhibits, the greater the number of contracts needed to hedge a position and vice versa. By some estimates, the new conversion factors will lower dollar values of basis points by roughly 20% and, as a result, lead to all hedge ratios being about 20% higher.
Q. Will the change in the coupon alter the duration of the bond contract?
A. Yes, durations will be longer.
The CTD bond will tend to have a higher modified duration at a given yield level, because the CTD issue will have a longer maturity and lower coupon. The increase in the duration alleviates the growing concern among hedgers that the current bond futures contract may be a less representative hedging vehicle for their cash market positions.
Q. Why was the delivery window of the 5-year contract changed, and what is the benefit of doing so? A. The purpose of this change is to increase the size of the deliverable basket.
When the U.S. Treasury switched from a monthly to a quarterly auction for U.S. 5-year T-notes in July of 1998, the number of issues eligible for delivery into the 5-year futures contract declined from as many as eight to only three. By allowing issues with a remaining maturity of 4 years, 2 months to be eligible for delivery, the CBOT will make one additional issue eligible for delivery each quarter. This will reduce the potential for squeezes and provide cash traders additional basis trading opportunities.
*Pending CFTC approval
For more information, call:
Cynthia Williams
312-435-7216
Nancy Kaplan
312-347-3808
Thomas Cosgrove
312-347-3823
©2009 Chicago Board of Trade. All rights reserved. Investor Relations | Site Map | Legal | Contact Us | 
| Subscriptions
| Subscriptions