What are Bond Futures?
Knowing the various financial instruments found in the market is important for any investor or trader. This allows for a diversified portfolio and less exposure to risk. This time we are going to learn about futures contracts on bonds. This is a financial derivative that you own as an underlying asset to a US Treasury or government bond. Bond futures offer extensive earning possibilities. Although, it is necessary to warn that the risks may be higher.
Bond futures in detail
When we talk about futures contracts, we are referring to an agreement between two parties. On the one hand, one of the parties agrees to buy. On the other side, the other party consents to sell a financial asset, the underlying asset. There is an agreement on the price and the expiration date of the contract. At that time, the seller must deliver the asset, and the buyer makes the payment. There is a clearinghouse to prevent any of the parties from breaching the agreement.
In the case of bond futures, the underlying asset will be a government bond or a US Treasury bond. Unlike option contracts, at the expiration date, the seller becomes obligated to deliver the active.
Futures contracts on bonds are considered highly liquid financial instruments. This is because there is a large number of buyers and sellers in the exchanges where they trade.
How do these contracts work?
Investors can have a variety of objectives when trading a bond futures contract.
By their nature, government bonds are assets that provide a higher level of security. With these products, the investor is covered from the shocks of the economy.
Both the buyer and the seller can speculate that there will be a price change in the fixed income market. In this way, it seeks to win with the difference in the future.
The investor considers that there is a decoupling between the asset’s purchase and sale prices. Try to profit by buying and selling simultaneously.
Upon signing a bond futures contract, the parties agree on a price. The buyer, which is the long part of the agreement, must pay the agreed price. At the expiration date, the seller – who owns the short position – must deliver the asset at the agreed price.
Where do you trade bond futures?
Like other futures and options, bond futures contracts are traded on the Chicago Board of Trade (CBOT). Initially, the CBOT traded agricultural products such as wheat, corn, or soybeans. The CBOT was founded in 1848. It is the oldest futures market in the world.
Over time, in addition to agricultural products, the trading of futures and options contracts was incorporated.
In 2007, this market merged with the Chicago Mercantil Exchange, forming the CME Group.
In bond futures, contracts can be signed taking these underlying assets:
- First: T bills: they are 13-week Treasury bills
- Second: T notes: these are the 2,3,5 and 10-year Treasury notes
- Third: T Bonds: they are the classic and Ultra Treasury Bonds
The Commodity Futures Trading Commission (CFTC) regulates bond future contracts. This regulatory agency is responsible for ensuring that fair business practices are followed.
The results of bond futures
Each of the parties involved in these operations has different interests. When an investor buys a bond future, he takes a long position. He speculates that the price of the bond will rise on the expiration date. If, on that date, the cost of the bond is above the price agreed in the contract, the buyer will have obtained a profit.
At the contract’s expiration, the buyer may choose to receive the bonds or open a sale operation to offset.
When an investor is a selling party in a bond futures contract, he takes a short position. Speculate that the price of the bond will go down. If the cost of the bond is lower than that agreed in the contract, the seller will make a profit at the expiration date.
Futures contracts on bonds can be an exciting option to obtain benefits. Bond prices can fluctuate. This is due to changes in interest rates, demand for the asset, or the economy’s state. However, these fluctuations increase the level of risk, and losses can be significant.
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