Bond futures are one of the most commonly used derivatives in the financial markets, allowing traders to speculate on interest rate movements and hedge against risk. 

Learn what drives bond futures pricing, contract specifications, and helpful tips and strategies to trade these versatile instruments.

What are bond futures?

A bond futures contract is an agreement between two parties to buy or sell a bond asset at a predetermined price on a specified future date. 

Bond futures serve two primary functions:

Speculation: Traders use bond futures to bet on the direction of interest rates. If traders expect interest rates to increase, they may sell bond futures. Conversely, if a trader anticipates a decrease in interest rates, they may buy bond futures. The decision to purchase or sell bond futures typically depends on the trader’s trading strategy.

Hedging: Bond futures allow fixed-income investors to hedge against losses from interest rate changes. For instance, a portfolio manager can sell bond futures contracts to offset the potential declines in the value of their bond holdings due to interest rate changes. This strategy helps to protect the portfolio’s overall performance and reduce the impact of interest rate risk.

Common types of bond futures include:

1. Treasury futures - Issued by the US government in maturities like 5-Year, 10-Year, and 30-Year
2. Eurodollar futures - Short-term contracts based on 3-month LIBOR rates 
3. Municipal bond futures - Issued by state/local governments and agencies
4. Corporate bond futures - Issued by individual corporations  
    

Mechanism of bond futures 

All standardised bond futures contracts have specific parameters fixed by the exchange where they are traded. These specifications include:

Deliverable bond

The underlying “deliverable” bond that can be delivered to satisfy the futures contract. For example, the 10-year US Treasury Note is the deliverable for the 10-year T-Note futures contract. The exchange outlines the specific acceptable deliverables.

Contract size 

The face value or principal amount of the deliverable bond. Popular contract sizes include $100,000 face value for US Treasury futures or $1 million face value for Eurodollar futures.

Minimum price increment (Tick size)

The minimum amount of the contract price can fluctuate up or down. Treasury note futures have a tick size of 1/4 of 1/32 of a point, or around $15.60 per contract.

Expiration date/cycle

The last day a contract is valid before expiration. Treasury futures expire quarterly - March, June, September, and December. Eurodollar futures expire four times per year.

Delivery months

The months in which the contract can be delivered - Treasury futures have delivery months corresponding to their expiration months.

Settlement procedures 

Process for settling the contract at expiration - physical delivery or cash settlement. Most bond futures settle with the physical delivery of the underlying bond.

Now that we’ve covered the contract specifications, let’s discuss how bond futures pricing works.

Pricing and valuation of bond futures 

The prices of bond futures contracts are derived from the market’s expectations for where the underlying cash bond price will expire. As a bond futures contract approaches its expiration date, the futures price will converge toward the cash market price of the underlying bond. This occurs because any difference would present an arbitrage opportunity.

For example, if 10-year Treasury futures were trading significantly below the cash market price of the deliverable bond, traders could simultaneously buy the cheaper futures and short the overvalued cash bond to lock in a risk-free profit. This activity brings the futures price back in line with fair value.

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Factors influencing the price of bonds  

Some of the factors that impact the pricing of bond futures include:

• Interest rates - The prevailing yields on the deliverable Treasury bond will be the most significant driver of futures prices. If the 10-year note yield rises, 10-year futures will decline.
• Federal Reserve policy - Outlook for Fed rate hikes or cuts will influence futures prices through anticipated impact on bond yields at expiration. 
• Bond volatility - Expectations for wider yield fluctuations will increase options-based volatility priced into the futures contract.
• Technical factors - Supply and demand imbalances for futures contracts can result in temporary mispricing. A large volume of buys may push futures above fair value.
• Roll yield - As the expiration date of a futures contract approaches, traders and investors must roll their positions over to the next contract. During this process, price discrepancies may arise between the expiring contract and the new contract, resulting in slight price divergences. Various factors, such as differences in the delivery months and the underlying supply and demand conditions, can cause these divergences.

Carry costs and futures valuation

An essential factor governing futures pricing is the concept of carry costs. This refers to the costs of holding the physical bond until contract expiration. For instance, buying and holding a 10-year Treasury note until delivery would require financing at short-term interest rates. This carry cost is built into the futures price - resulting in the futures trading below the spot cash bond price.

The difference between the futures price and cash market price is called the “basis”. Traders who have a firm grasp on the concept of the basis can exploit discrepancies between futures and cash prices to execute profitable trades. The basis relationships are also vital for relative value and arbitrage trades.

9 tips on trading bond futures 

1. Learn about bond futures and how they work. Bond futures allow you to speculate on the future direction of interest rates. They are based on debt issued by governments and corporations.
2. Decide which bond futures contract you want to trade. Popular ones include the 10-year T-Note, 30-year T-Bond, 5-year T-Note, and 2-year T-Note. These are issued by the US Treasury.
3. Open a futures trading account with a broker that provides access to the bond futures markets. You’ll need to meet account minimums and fill out applications.
4. Understand contract specifications like tick size, tick value, contract months, delivery dates, etc. 
5. Use technical and fundamental analysis to decide whether to go long (bet on rising bond prices) or short (bet on falling bond prices). Factors like economic data and interest rate policy must be monitored regularly.
6. Place orders to buy or sell bond futures contracts. You can use market, limit, and stop orders. Be sure to maintain proper position sizing and manage risk.
7. Monitor the markets closely and be prepared to exit positions. Bonds are volatile and sensitive to news events. Use stop losses to protect against large losses.
8. Be aware of expiration dates and the delivery process. You generally want to close out positions before expiration to avoid taking delivery. Roll over to a further dated contract as expiration approaches.
9. Use trading techniques like scaling into positions, using stops, managing leverage, and not overtrading. Futures trading involves a substantial risk of loss. So approach with caution and informed prudence.

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Strategies for trading in bond futures

Here are some of the most popular strategies used by traders:

• Speculating on rates - Buying or selling based on your interest rate forecast. Going long if you expect declining yields, short if you expect rising yields.
• Roll yield - Capturing slight pricing distortions when futures contracts approach expiration and need to be “rolled” into the next contract.  
• Arbitrage - Profiting from slight mispricings between futures and the underlying cash bonds. Requires actively monitoring basis trading relationships.
• Curve steepening/flattening trades - Positioning for an expected change in the yield curve slope, such as going long the 10-year and short the 2-year contract if you expect the curve to steepen.
• Intra-market spreads - Taking spreads between different contracts within the bond futures market, like shorting the current 10-year contract and going long the next deferred 10-year contract.

To sum up,

Bond futures let traders speculate on interest rate movements and hedge against fixed-income risks. The prices of bond futures contracts are derived from expectations of where cash bond yields will expire—factors like prevailing interest rates, Federal Reserve policy, and technical dynamics influence bond futures pricing. 

Traders must implement strategies like taking positions based on rate forecasts and capturing roll yield between contracts, arbitrage, and curve trades to increase the chance of making a profit on this type of investment. 

Trading bond futures are possible on markets.com

Bond futures can be accessed on trading platforms such as markets.com. Our platform lets you trade through a contract for difference (CFD). In this type of trading, you will be speculating the price of your chosen CFD bonds without having an actual asset. 

If this is your first time trading on CFD bonds, do not hesitate to expand your knowledge with markets.com’s Traders’ Clinic Podcast. Gain valuable insights on how to overcome common mistakes and gain a better understanding of the markets and finance. 

Aside from the educational resources we provide you, you can also access our free expert trading tools when you open an account. Our tools analyse key market indicators to give you a complete picture of what’s happening right now so you can make confident, decisive moves based on the facts. 

Discover the benefits of trading with markets.com today!

When considering “CFD Bond Futures” for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”