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The Guide For the Active Day Trader

Part 1: The Basics

What are Interest Rate Futures?

The Inverse Relationship
Fixed Interest Futures Pricing
Tick Values and Other Specifications

Part 2: The Yield Curve

A. What is the Yield Curve?
B. How the Yield Curve Moves
C. Factors Affecting the Slope of the Curve
Part 3: Dollar Value Analysis - DV01s

What Are DV01s And Why Do You Need Them?
Trading Example 1: US Yield Curve
Trading Example 2: Au:US 10s:10s Spread
Trading Example 3: The 10s Overreact On Open
Hedge Ratios

Part 4: Spread Trading


Executing Spreads
Charting Spreads
When is a Spread Not a Spread
Some Spread Research Ideas

Part 5: Trading Setups


The Laggard
The DV01 Gapper
Yield Curve High Jinx 5, 10, 30 example
Last to go (data)
Other setups

More Information
About The Author and Contact Details

Assumed Knowledge:
Mechanics of futures contracts.
A very basic definition of spread trading.
A very basic understanding of market depth.
There must be hundreds of books out there that suggest they will show you how to trade a
certain market with specific tools then simply end up showing how to read a chart or spot a
breakout. That is the generic market analysis that has been around for years and years.
At Propex, we set out to write this guide with the goal of NOT pumping out something
people have read before. This guide is specifically designed for our trainee bond futures
traders. It is also applicable to anyone else interested in bond markets.
It covers topics that are specific to trading bonds. We are not covering the hardcore maths
so much, but covering things such as yield analysis (instead of just price analysis) and other
factors specific to the Australian and US fixed interest futures markets.
All in all, they are great markets to trade and offer some fantastic opportunity when traded

Part 1: The Basics

1A: What are Interest Rate Futures?
There are a whole range of futures products from around the world that are in some way or
another a derivative of an interest rate. There are swap futures, bond index futures,
sovereign yield spreads, Fed Funds, Euribor, Tibor, Eurodollar and plenty more.
The best place to start when looking at interest rate futures is with notes and bonds as
opposed to shorter dated instruments. In this lesson, we are going to cover the US
Treasuries and Australian government bonds. These are two well established markets: one
is a global benchmark with very deep liquidity; the other is not as liquid and is more a
follower than a leader.
Before we go further, it should be pointed out that this lesson will not cover every topic in
every market. This material is designed for our traders here at Propex plus those wanting to
be traders to gain an understanding how bond markets works. There are some topics that
will not be covered because they are not deemed important at entry level and create more
confusion than anything else.

It should also be noted that we use the term bond throughout this lesson as a generic term
for fixed interest futures that includes both notes and bonds. Same, same unless otherwise
So, What is a Bond?
A government raises money in two ways: taxes and borrowings. Borrowings are in the form
of bills (short dated), notes (short to medium dated) and bonds (long dated).
In most developed economies, a futures exchange will make contracts available based on
the active and available securities issued by the government.
Lesser developed countries are less likely to have a significant long dated securities market
given the sovereign risk. Alternatively, more developed economies will have a spread of
In Australia, there are 3yr bonds and 10yr bonds (plus bank bills and the cash rate futures).
In the US, given it is a more developed bond market, there is everything from the Fed Funds
rate out to the ultra bond, a 25yr+ futures contract. The key markets in the US, and the
ones we will look at here, are the 5yr note, 10yr Tnote and the T-bond. In most developed
markets, the 10yr bond is the benchmark security.

1B. The Inverse Relationship

Now, we have we have read that the price of a bond in inversely related to its yield, but how
does that actually work? The easiest way to explain is with an example
Lets say the government (via the Treasury) wants to borrow $100. The bond is offered to
the general public and the market price for the bond is determined at 6%.

The basic structure is that the investor gives the government $100 and the government then
gives the investor a piece of paper that says it will pay $6 (6% of $100) for the life of the
bond plus the $100 back at maturity. Note, that percentage, called the coupon is fixed for
the life of the bond.
That transaction is conducted in what is called the primary market. There is also a secondary
market - a market in which the investor can sell their bond to someone else. Naturally, it

makes sense to be able to sell the bond if the holder doesnt want to keep it for the whole
If over the whole 10 years, interest rates remain at 6%, then the value of the bond will
remain constant and the pricing of this bond is pretty straight forward. However, interest
rates can and do change on a daily basis.
If interest rates rise to say 7%, new investors will be able to lend to the government for 7%
and would have no interest in buying a bond paying only $6 IF the price of the bond remains
the same.
It is not only the price of the bond that varies, the effective yield received from the bond
paying $6 also varies. Thats the important bit.
If we fast forward the above example by one day and for whatever reason interest rates
have increased by around 50 basis points. That means a 10yr bond should be paying around
Naturally, a new investor would rather buy a bond paying $6.50 per annum than one paying
$6.00. If the owner wanted to sell the 6% bond in the secondary market they would have to
adjust the price to make the $6 payment equivalent to a 6.50% return on the amount paid.
Would the price of the bond have to go up from $100 or down? If it went up, the effective
return would be even less in terms of percentage of the amount paid. If the price went
down, that effective yield would increase.
What if the price was $50 instead of $100? Excluding the effects of time (its only been one
day) $50 to earn $6 per annum plus $100 at maturity is a very good yield. Using a bond
pricing formula, it would be close to 16.5%.
The bond pricing formula by the way is not worth discussing here. Financial calculators have
the pricing function. If now, youll find one with a quick search on Google
Getting back to our example, lets look at the price of the bond as rates go from 6% to 6.5%.
Again, plugging the numbers into the bond pricing formula and assuming interest is paid
semi-annually (as it is for most bonds) we have a price of $96.37.
So that means that a bond paying 6% per annum (paid semi-annually) and priced at $96.37
is the same as a bond paying 6.5%pa and priced at $100.
This outcome shows you WHY prices fall when rates rise. It allows one bond to be
comparable to another. With most bonds on issue there are only two things that can
possibly change. One is the passing of time (unfortunately unavoidable) and the other is the
bond price. It is the price of the bond that is the variable in the secondary market.
So to further illustrate the inverse relationship, lets calculate some prices given a change in
yield for a $100 par value bond paying 6% per annum, paid semi-annually.

These numbers were calculated using a bond pricing formula found through a Google
search. You dont need to understand the formula to understand the relationship.

1C. Fixed Interest Futures Pricing

If youve come from a share trading background, looking at bond prices can at first be a little
confusing. Shares are quoted in dollars and cents. What is hard about that? Bonds on the
other hand are a little trickier. Once explained however, its pretty logical.
Firstly, all bonds are quoted in terms of price not yield. Thats why we had the section on
the inverse relationship. Most global contracts are priced in a similar way to the US
Treasuries. Aussie bonds are different.
Aussie Bond Futures
The Aussie 3yrs and 10rs are quoted as: 100 minus yield.
So a yield of 4% would mean a price of 96.00. A yield of 4.01% would be 95.99. This
approach is the same as the global standard for short term interest rate futures such as
Eurodollars, Euribor and the Australian Bank Bill Futures.
US Treasuries
The US market has a different way of quoting fixed interest futures. Prices are quoted as a
percentage of a $100 par value. Thats a little confusing at first, but its not that complex.
Like most other bond futures contracts, the US Treasuries are based on a standardized
contract with a fixed coupon of 6%. A price spot on 100-00 means the yield is equal to the
coupon of 6%. A price above 100 implies a lower yield and a price below 100 implies a
higher yield (remember the inverse relationship).
A price of 110-00 means the bond is trading 10% above the parity price of 100. Without a
bond pricing formula, you cannot determine what the yield is from that price. Suffice to say
its less than 6%.

Just to illustrate the point, using a bond pricing calculator found online, a price of 110-00
would mean a yield of 4.73%.

1D. Tick Values and Other Specs

Both the Aussie bond futures and the US Treasury futures are based on a contract with a
$100,000 face value and 6% coupon.
The coupon of 6% does not change from one expiry to the next. It might seem logical for an
exchange to match the coupon rate to the current physical government bond rate, but
keeping it steady is actually more logical. Keeping it at the same rate means that there is
essentially just one variable from contract to contract the price. The price is what is traded
in the open market so it stands to reason that all other contract specifications are fixed.
If we had a coupon rate that kept changing from one contract to the next, volatility would
change, DV01s would be all over the place (more on that later) and hedge ratios would just
be confusing. So it is kept at 6% to maintain a degree of consistency.
Do we really need to know all this stuff about coupon rates? Not really, but it does help to
understand how these contracts are priced. This next section gets a little more specific on
how Australian bonds and US Treasuries are priced on the screen. That is the need to know
Whats in a Tick?
The term tick refers to the smallest possible movement in a contract and tick value refers
to the dollar value of that movement. For example, most shares will have a tick of 1 cent
and if you held 100 shares, the tick value would be 100 cents ($1).
Every futures contract is based on a certain amount of the underlying asset. For example,
crude oil futures are based on 1000 barrels of oil. The tick size is 1 cent and therefore the
tick value is $10 (1000*$0.01).
Given the way bonds are priced, there is a bit more to understand when it comes to tick
Aussie Bond Futures
Remember Aussie bonds are priced as 100 yield. That is, we are actually trading the
inverse yield rather than a dollar based contract. This has implications on the tick values.
The 3yr and 10yr bonds each have different tick values. To understand why involves
knowing all about DV01s a topic we cover in a few pages time. For now, well cover the
The Aussie bond futures have a variable tick value. This is because the dollar value of one
basis point changes given changes in yield. For example, the dollar value of a move from
95.01 to 95.02 is different from a move from 96.01 to 96.02.
The ASX have a spreadsheet to calculate the tick value here:
The following table summarises the values at the time of writing:
Tick size
Tick value

0.01 (a full basis point)
A move from 97.63 to 97.64 is
worth $30.58.

0.005 (half a basis point)
A move from 97.01 to 97.015 is
worth $49.33.

Note, in the 10yrs some talk about a tick being a full basis point (0.01) and then refer to a
0.005 move as a half tick. Others, and this is the correct way to do it, refer to the smallest
possible move (0.005) as a tick. Its just something to be aware of.
US Treasuries
The CBOT futures contracts (the 5yr note, the 10yr note and the bond) are all valued at
$1000 per big figure. That is, a move from 120-00 to 121-00 is worth $1000. However, like
the Aussie bonds, the tick size for each contract is different.
First of all, just to confuse the issue, US Treasuries do not trade in decimals. Rather, they
trade in 32nds and fractions thereof. That move from 120-00 to 121-00 is a move of
The following table summarises the tick values:
Big Figure value
Tick size
Tick value

5yr Note
One quarter of
$1000/32/4 =

10yr Note
One half of 1/32

The T-bond

$1000/32/2 = $15.625

$1000/32 = $31.25

This next point is confusing at first, but it makes sense once you think about it. The 10yr
note does not trade in 64ths.They trade in half 32nds. The 5yr note does not trade in
128ths. They trade in quarter 32nds.
Whats the difference you say? Well of course in dollar terms its the same thing, but they
are quoted as 32nds (and fractions thereof) so its easier to make a side by side comparison.
A whole 32nd move in each of the contracts is the same dollar value ($31.25) but it takes the
5yrs four ticks to get there; the 10yrs two ticks to get there and the Tbond just one. So lets
add a tick value example to the table:
Big Figure value
Tick size
Tick value

5yr Note
One quarter of 1/32
$1000/32/4 =

10yr Note
One half of 1/32
$1000/32/2 =

The T-bond
$1000/32 =


A move from
124-155 to 124-157
is worth $7.8125.

A move from
133-00 to 133-00
is worth $15.625.

A move from
147-20 to 147-21
is worth $31.25

Note, most systems remove the decimal place so that 124-115 shows up as 124155. Its just
something to get used to. Others use a dash instead of a decimal point or an asterisks or
Most systems also drop the last digit for a quarter tick in the 5yrs. So its 124157 instead of
1241575 (too many numbers!).
So lets see how these things look on the depth display:

Overall, bond pricing is a little trickier than pricing for shares or other futures contracts, but
it just requires some basic knowledge.

Part 2: The Yield Curve

This is a bit of a sideways move from the discussion so far, but it is a need to know topic if you are
looking at more than one bond market (and you should be!).

2A. What is the Yield Curve?

The yield curve is a graphical representation of market yields across different maturities. The y-axis
shows yield. The x-axis shows time to maturity from shortest to longest.

Naturally, it is the change in the yield curve that concerns us. In most cases a move in the curve will
be a change in the slope of the curve.
Terms to know:
Short end of the curve securities with short dated maturities.
Long end of the curve securities with long dated maturities.
The belly not quite short end, not quite long end, right in the middle.

2B. How the Yield Curve Moves

Non-parallel changes in the yield curve are categorized as steepeners and flatteners. Both have
bullish and bearish scenarios.
Steepeners are where the difference between the long end and short ends increases. The terms
bullish or bearish refer to the direction of prices.
Yields fall = bullish = lower rates
Yields rise = bearish = higher rates
Bull Steepener this is where rates are falling (prices rising) and short term rates are falling faster
than longer term rates.

Bear Steepener this is where rates are rising (prices falling) and long end rates are rising faster
than short end rates.

Flatteners are where the difference between the long end and short ends decreases. The terms
bullish or bearish refer to the direction of prices.
Yields fall = bullish = lower rates
Yields rise = bearish = higher rates
Bull Flattener is when yields are falling (prices rising) and the long end is moving further than the

Bear Flattener is when yields are rallying (prices falling) and the short end is falling harder than the
long end.

2C. Factors Affecting the Slope of the Curve

Economic Cycle. During periods of strong economic expansion, short term yields will often move
higher than longer term rates and the yield curve will be inverted. As the economic conditions turn
negative, shorter term rates will go back below long term rates and the yield curve takes on a
normal shape. As rates move lower still, the curve will steepen. As the recovery gets underway,
the curve can flatten as short term rates rise.
Another scenario that may cause an inverted yield curve is the perceived risk of default of
government debt (eg Greece). This image shows the yield curve in the middle of the Greek crisis.

Inflation. The yield curve will be steep when expectations for short-term inflation are low.
Expectations of strong inflationary pressures will flatten the yield curve.
Monetary Policy. The yield curve will steepen when the Central Bank moves towards a loose
monetary policy. The curve will flatten and can gradually move inverted when policy is tightened.
Operation Twist in 2011 was a good example of the US Feds policy changing the yield curve. In
September the Fed announced they would sell short term bonds and buy long term bonds in an
effort to reduce longer term rates. The effect of such a policy is to flatten the curve by increasing
short term rates and reducing long term rates.
The curve trade to make in this scenario would to be to get long the 30yr bond and spread off with
shorter term notes such as the 2yrs. In two days the long end rallied over 5 handles whereas the
short end hardly moved (nobody expected much of a change in short end rates given the Feds
commitment to keeping short end rates low).
Supply of and Demand for Treasury Bonds. Activity in treasury financing (supply) and large managed
funds (demand) can also have an effect on the yield curve. Specifically, supply or demand constraints
in particular maturities can lead to changes in the relative prices of certain points along the curve.

Part 3: Dollar Value Analysis - DV01s

3A. Introduction
This part looks at fixed interest futures trading from the point of view of DV01s or Dollar Value Of1
basis point. The DV01 is used for what we might call relative value analysis. This is the concept that
is most useful when looking at two or more related markets.

Here we will continue to look at the US Treasuries the 5yr Tnote, the 10yr Tnote and the 30yr
bond. We will also look at the Australian bonds the SFE 3yr and 10yr bonds.
For most readers, I expect the concept of a DV01 to be new and of course we will ask if it is worth
learning? The answer is pretty simply yes, it is worth learning. The concept itself is relatively
simple; the data is easy to find, and more importantly, it helps to find good trades. Nuff said!

3B. What Are DV01s And Why Do You Need Them?

We may all look at price charts for our levels, technical patterns and so on, but it is yield not price
itself that dictates where bonds trade. The very new trader will look at prices only. More
experienced traders know that analysis of yield is very important and opens up trading opportunity.
The DV01 calculation allows us to compare one interest rate security with another even if those
securities are traded on different exchanges or in different currencies. The DV01 is also used to
calculate hedge ratios for spread positions and derive a standardized format for charting spreads.
Firstly, the definition - The DV01 is a DOLLAR VALUE calculated for an interest rate security that
represents the CHANGE IN PRICE given a one basis point change in yield. That is, a DV01 shows the
dollar value of the change in the bond price given a one basis point change in yield.
We all know this relationship:

That is, prices are inverse to yield, but what is the exact relationship? If we are going to look at
trading these markets together, we need to know how they relate.
Thats what DV01s tells us. It is the dollar value change in price of the fixed interest security given a
fixed one basis point change in yield.
Aussie Bond DV01s
The ASX(SFE) bond futures are quoted:
Price = 100 - yield
Therefore the DV01 is simply the same as the value of a 0.01 move. Currently, these are:
AU 3s:

DV01 in AUD

DV01s in USD

AU 10s:



The pricing convention for Aussie bond futures is similar to most short-term interest rate futures
around the world such as Eurodollar and Euribor. Therefore the DV01 for these short term securities
is also simply the tick value for a $100,000 equivalent (the face value of the bond contract).

Given the way the 3yrs and 10yrs are priced, the DV01 changes as the price changes, albeit in small
increments. The SFE have made available an excel template to calculate the numbers. Download it
US Treasuries
Its a little harder to calculate DV01s for Treasuries given they are quoted in price not yield.
Calculating DV01s from scratch requires the use of the bond pricing formula. The easier way is to
look them up. See this link for more information:
Currently we have:
5yr Tnote:
10yr Tnote:
30yr Tbond:



Tick Increment
Quarter 32nds
Half 32nds
Whole 32nds

Approx Ticks
7 quarter 32nds
5 half 32nds

Note, the 2yr Tnote has been left out of this table given its different contract value.
These numbers essentially show the change in price of the respective bond futures contract given a
1 basis point shift in the yield curve.
This is an interesting table to analyze. It essentially tells us how far each contract will move given a 1
basis point change in yield. In other words it tells us how far market A should move if market B
moves by X amount.
The US Treasuries trade in 32nds and fractions thereof. This in itself can make relative value analysis
a little confusing. However if we starting thinking in 32nds, we can have a rule of thumb idea on how
much one market should move given a move in another.
Naturally, this assumes that the two or more securities will move by the same number of basis
points. If this were a 100% valid assumption, there would be no trading opportunity. However, this
assumption is where we start with our analysis. Its used as a point of comparison.
So with the DV01s in hand, lets go through a few examples.

3C. Trading Example 1: US Yield Curve

Question: If we see the 30yr Tbond move up 10/32nds, what would we expect the 5yrs and the
10yrs to move by?
Answer: We will calculate the price movement given the same change in yield.
Step one is to calculate how many basis points are in 10/32nds.
30yrs - Given:


DV01(30yrs) = 166.52
1/32nd = $31.25 tick value

1 basis point equals 166.52/31.25 ticks. Thats 5.33 ticks.

The market has moved 10 ticks. That is 10/5.33 = 1.88 basis points. This says as price moved up 10
ticks, yields fell by 1.88 basis points.
Step two is to calculate the price change in the 5yrs and 10yrs given a 1.88bp change in yields for
each contract.
10yrs - Given:

DV01(10yrs) = 78.30
1/32nd = $31.25 tick value

1.88 basis points equals 1.88 * 78.30/31.25 ticks. Thats 4.70 32nds. In practice that is between 4.5
and 5 32nds.
5yrs - Given:

DV01(5yrs) = 51.05
1/32nd = $31.25 tick value

1.88 basis points equals 1.88 * 51.05/31.25 ticks. Thats 3.065 32nds. In practice that is between 3
and 3.25 32nds.
So a move of 10/32nds in the Tbond should see a move of around 3/32nds in the 5s and 5/32nds in
the 10s.
If we see a scenario where this is not happening, there is opportunity. Consider this:




5yr Tnote:
10yr Tnote:
30yr Tbond:




Approx Change in

If we see those changes in price for the three treasuries, we have quite different changes in yield.
The 5s and the 10s changed by less than 2 basis points where as the Tbond change by 3 basis points.
Has the Tbond moved too far or have the 5s and 10s moved too little? Its hard to say. Perhaps the
trade to make is to be long both 5s and 10s and short the Tbond. This would benefit from
realignment on the yields.
The Rule of Thumb
Use DV01s as a rule of thumb for how much a market should move given a move in a closely related
From the numbers above, one basis point in each security works out to be:
5yr Tnote:



10yr Tnote:
30yr Tbond:



So a move of 2.5 32nds in the 10s should see a move of around 1.5-1.75 32nds in the 5s and around
5 32nds in the Tbond.
This rule of thumb is the starting point for your analysis. Naturally it does not factor in changes in the
slope of the yield curve, driven perhaps by some unexpected news or data release. It is simply the
place to start.

3D. Trading Example 2: Au:US 10s:10sSpread

What we call the 10:10s spread is the spread between the SFE 10yr bond and the CBOT 10yr Tnote.
It is a spread that shows both long term and intraday correlations, but those correlations are not
perfect. As such it can offer opportunity when the spread gets out of line.

Pick any period chart (the above is daily) and youll see the two are highly correlated. The question
we must ask however is how can we spot the trading opportunity? The answer lies in using .DV01s.
Given the two contracts are priced differently the way to compare them is by applying the DV01

US 10yrs:


1bp =
2.51 32nds

AU 10yrs:



What this table tells us is that if the Aussie market is going to follow the US, then a move of 2.5
32nds in the Tnote will be equaled with a one tick move in the 10yrs. This is quite interesting and
very applicable.
Lets say we have a scenario where before the Aussie market open, we see the 10yr Tnote on Globex
trade 20 32nds higher. Naturally we would expect the Aussie 10s to open higher, but how much
If we make the assumption that the Aussie market will follow the US, a 20 tick move in the Tnote
should see an 8 tick move in the Au 10s:
20 32nds = approximately 8 basis points (20/2.51)
Thats a pretty simple calculation and interestingly the assumption that yields will move together will
often hold true but not all the time. It is at those times where we see a divergence that the trading
opportunities present themselves.
If, for example we say the Au 10s open 4 ticks higher, not 8; in most situations, that would be a
pretty low risk buy.
Tightening up on risk, you could even sell the Tnote at the same time as buying the Aussie 10s and
thereby create a spread. While there is no reason the US market will take a lead from the Aussie
markets, a quick reversal in the Tnote could mean you can cover your Aussie 10s with little impact
and make a little on the Tnote. Rather than think of the 10:10 as a spread, think of the Tnote as
temporary insurance against the long Aussie position.

3E. Trading Example 3: The Au 10s Overreact On Open

The PM Close/Re-open Trade
When the Aussie bonds close at 16:30 and then re-open at 17:12, the US Treasuries remain open.
Those trading the re-open, look to the Treasuries for a clue on where the SFE bonds market will reopen and move within the first few minutes of trade.
On this particular day we had a close in the Au bonds at 96.725 while the Tnote was trading at
132*29. On the reopen of the Au bonds at 5:12pm, the Tnote had lost 3.5/32nds.

Now, we know a 2.5/32nd move in the Tnote is equivalent to a 0.01 move in the Aussie bonds, so
youd expect a reopen around 96.710-715.
Interestingly, the market re-opened at 96.705 and immediately traded down to 96.675. There was
no other news and the Tnote did not continue lower.
The trade to make here would be to buy all the way down to 96.675 with a very short term outlook
for upside. As you can see on the chart the market came back within minutes offering up a few ticks
in profit.
Interestingly, the Aussie market again made a dip lower shortly thereafter. (See the circled areas on
the charts.) Note how the Aussie market made a new low that was not matched by the Tnote. That is
another high probability long Au bond trade worth a few ticks.
Spread Anyone?
So should these long Au bond trades have been spread-off with the US Tnote? The answer is maybe.
In this example spreading/hedging would have worked well, but being long the Au 10s was also a
good trade. There are times when it pays to spread against the US, but there are plenty of other

opportunities where we just see the Au 10s playing catch up or coming back from an over-reaction.
In these scenarios, the simpler trade is not to spread.
Should We Look at Other Markets?
During the Sydney winter (non-daylight savings), the European markets get into the swing at 16:00
Sydney time. That is 30 minutes before the Au day session close. This means their opening market
volatility can translate to volatility on the close/re-open in the Sydney markets. More often than not,
a certain move in Europe will also be seen in the US Treasuries, so watching the US is OK. However,
there are times when specific levels might be broken or tested in the European markets and as such
can have implications in the Sydney market.
During Sydneys summer, the Euro markets get into action at 18:00 Sydney time. That is after the reopen. Its worth watching the European open for potential turning points in the Sydney market
around this time.

3F. Hedge Ratios

The DV01 is also used to calculate theoretical hedge ratios for spreading. Again we start with the
assumption that yields will move together. That being the case the hedge ratio is simply the ratio of
respective DV01s.
Lets take the US 10yr:30yr spread notes over bonds, or NoB spread. We use the DV01s to
calculate a ratio of contracts whereby the dollar value of a one basis point change is the same in


US 10yrs:



US 30yrs:


This is a simple ratio to calculate. The DV01 for the 10s is about half that of the 30s. Therefore to
have the same dollar impact given a fixed change in yield, we would trade 2 10yrs for every 1 30yr.
The exact ratio is not quite 2:1 but its close.
Is this a perfect hedge?
Absolutely not. Think of it as a starting point. If we are looking at a yield curve spread for example
the 10s:30s, then a perfect ratio would assume an equal move in yield. In yield curve talk this is
known as a parallel shift. For smaller movements, this may hold true, but for movement driven by
fundamental shifts in economic conditions (hence interest rate cycles), the change in the yield curve
will rarely be parallel.
With this in mind, trading a spread will most often be a directional position of sorts. However this is
the whole point of spreading as least from a speculative point of view. A perfect hedge means zero
profit potential and zero movement in the spread. We want movement in the spread.
Next is a chart showing both the 30yr Tbond and the 10yr Tnote on the same price scale.

If you look closely, you can see them moving in the same direction at the same time. Thats to be
expected. What is easy to see on the chart is that the Tbond, the one on top, is far more volatile.
That is to be expected given DV01s. A one basis point shift in yield sees a bigger impact in the Tbond.
Now is all that hedged out with a 2:1 ratio? Not quite. Take a look at the next few charts. They show
the dollar values of being in the spread at different ratios. Lets look at the price movement from the
last month or so.

The first chart shows a 2:1 spread (long 10s and short 30s). As prices fell overall, a 2:1 ratio spread
widened, essentially showing a profit. If we were looking for a hedge, it would mean a 2:1 spread
would have been underweight in the 10s.
The next chart shows a 3:1 spread. The value in the most recent month narrowed, or fell, signifying
we were long too many 10s.
The correct ratio was closer to 5:2 (2.5:1). By correct ratio we mean the amounts at which the net
result on P&L would be near zero. That is a hedge. Anything else is a directional position.
So what is the point of all of this? Essentially it demonstrates that yields do not move point for point
across the yield curve. We knew that, but its useful to see how it plays out with real prices.
For the speculator, it means we have to take note of the effect of direction in the underlying market
when placing a certain spread. In practice, traders will adjust the ratio of a spread to suit their view
on direction overall. Makes sense.
The discussion of hedge ratios is a bit of a tangent from the relative value topic, but before putting a
spread on, we need to have an idea of what the spread will do in certain circumstances and the

answer for that is different for different ratios. DV01 calculations are the place to start when looking
at hedge ratios.

3G. Summary
Hopefully the examples of trades showing DV01s in action is enough to demonstrate the power of
understanding DV01s. We use DV01s to better analyse movement in bond prices on a relative basis.
If we are trading one market and looking only at one market, you could argue DV01s are not
Once we start looking at more than one market (and who doesnt?), then the DV01 analysis
becomes quite important.
As previously mentioned, those new to bond trading may not have heard about DV01s. Ironically,
the numbers are easy enough to get and applying the rules of thumb is not that hard. If it means
finding good trades, then why would you not use it?

Part 4: Spread Trading

Futures spread trading is a massive topic and unfortunately very little has been written on it. This
section is not going to look at every type of spread. Insterad, just the simplest.
The simplest form of a spread

4A. Executing Spreads

There are three ways to enter a spread:
Exchange Traded Spreads. The simplest way to transact in a spread is
when the exchange offers that spread as an exchange traded
product. The CME offer the NoB (10-30) as an exchange spread
pictured here.
The thing to note here is that a one lot trade in the spread equates to
a traded amount in each contract equivalent to the ratio set by the
At the time of writing, the NoB spread trades at a ratio of five 10yrs
and three 30yrs (as opposed to what we calculated at 2:1 in the
previous pages close, but not exact).
Autospreader. Trading platforms such as TT and CQG have a
spreader feature where you can program a tradable synthetic
spread. The end result is the ladder is tradable much like an exchange
traded spread.
Legging. The good old fashioned method to enter a spread is roll up
your sleeves and enter each leg manually.
A tip for the best entry is to identify which market is most volatile and work a limit order entry in this
market. After getting a decent price in the choppy market, go to the second market and either work
best bid/offer or hit market.
Legging in a spread can be a tricky method to get used to, but youll get the hang of it with a little
Terms to know:
Leg refers to each part of a spread trade.
Legging refers to entering a spread trade one leg at a time.

4B. Charting Bond Spreads on CQG

Wouldnt it be easy if every contract we look at is traded in the same currency and quoted the same
way? Unfortunately they are not. So to chart these spreads, we have to make a few calculations.
The easiest way to chart these spreads is to bring them back to yield. CQG has a function where it
can turn a fixed interest security price into a yield chart. From there, we simply calculate the spread
price and chart.

So to chart any of the US Treasury spreads for example, the following codes would be used:
US Spreads


"Tuf" Spread
"Tut" Spread
"Fight" Spread
"Fob" Spread
"Nob" Spread

Then right click the title bar, select More, then Yieldas the above image shows.
The same goes for the US-Aussie spreads. We do not need to convert the currency of one to the
other as we already did this when calculating the hedge ratios earlier. With the yield function on
CQG, it is comparing apples with apples.
The codes are:
Aussie Spread
US - Aussie Spread

"3s, 10s"

Note, this method of charting looks at the futures yields, not cash note/bond yields. There is often a
difference between futures and cash (known as basis).

Filtering Data

When trading a cross-border spread, it can be useful to filter the display to show only certain trading
hours. You might do this if you are trading the US-Au spreads during the night session only.

Alternate Method of Charting a Spread

On CQG there is a function called SHAREDSCALE. It takes one market and puts in on the same price
scale as another. US Treasuries are quoted in 32nds and fractions thereof. The SHAREDSCALE
function allows you to change that back to decimal therefore making it easier to either chart a
spread or overlay one or more markets. For these charts, we will convert Treasuries to decimal using
the Eurodollar (code:EDA) market.
This approach to charting spreads adjusts the price of the securities by its DV01 so the dollar value of
an up or down tick on the chart is constant. Note, the DV01s change regularly and therefore so do
these numbers.
The CQG formulas for his approach are:
Two-legged US Spreads:









2s/5s/10s: SHARESCALE((TUA?1/DV01 -FVA?1/DV01)-(FVA?1/DV01-TYA?1/DV01 ),EDA)
5s/10s/30s: SHARESCALE((FVAH2/DV01 -TYAH2/DV01)-(TYAH2/DV01 -USAH2/DV01),EDA)
US-Aussie Spread:

US10-AU10: (TYA?1/DV01 -HXS?1)

* Look up the DV01 for each security for these calculations.

Varying the Spread Ratio

Ok, the hedge ratios calculated a few pages back assume a parallel shift in the yield curve to
maintain the perfect hedge. Given that a change in the slope of the curve is far more common than a
parallel shift. This is evidenced simply by the fact that the spread chart does not remain constant it
moves up and down.
So even with a theoretically perfect hedge ratio we are taking a directional position with any spread.
The short cut to working out the directional position is to overlay the spread with the outright and
look for the correlation.

4C. When is a Spread Not a Spread

1. Bad Timing - A spread should not be used to cover up a bad trade.
Consider this scenario: Trader Ted gets long the Tbond at 142-26 after what he sees as a decent rally
and one he expects will continue (exhibit A).

The market then falls away, down to 142-00 before Ted decides to act. Rather than stopping out the
trade and admitting the trade was simply a bad one, Ted sells some 10yr notes against it, thinking he
will spread it off and watch it come back (exhibit B).

Think about the logic here. Ted is 26/32nds offside and then enters into a position that will require
the bonds to rally well beyond his original buy price just for that spread to make a decent advance.
Pure logic suggests he has a far better chance of simply holding the outright bonds in anticipation of
a bounce.
Admittedly, the trade would reduce the downside if the market kept falling, but it virtually gives
away any chance of making back the ticks already lost.
As a rough estimate, the bond would have to rally by twice as much as the fall for that spread to
make back the lost ticks.
Turning an outright losing trade into a spread is not a spread strategy.
Admittedly the example above shows a trade that was off side by a large amount before spreading.
However, exactly the same logic applies to smaller moves. Spreading something off makes it harder
for you to make money.
2. Bad Correlations A spread involves opposing positions in correlated markets and the
same positions in inversely correlated markets.
Most of the time, stocks and bonds are inversely correlated. It is not unprecedented for a trader to
spread these markets, perhaps trading relative values or extremes in one versus another.

So what does a spread in say the S&P versus the Tnote look like? Are you long one and short the
other? If you think about it, that is a double directional trade. If they are inversely correlated (stocks
go up bonds go down), then being long one and short the other is taking an even bigger directional
position that you would be trading just one of the markets outright.
The correct spread trade to make in inversely correlated markets is to be long both or short both.
That is a spread.
3. Bad Ratios

If we look at the Aussie 3s:10s spread as being a 3:1 ratio, then are you spreading when you are long
30 threes and short 30 tens?
The answer is yes and no. One way to look at it is you have a spread of 30 threes and 10 tens PLUS
another 20 tens. You are essentially overweight in one leg of the trade and therefore adding a
directional bias.
There is nothing wrong with doing this if it fits into your view, but its not a simple spread trade in
the strict definition. Placing these trades requires a directional view as well as a relative value or
spread view. In many cases you may simply be better off placing a smaller directional trade.

4D. Some Spread Research Ideas

We are born alone, we trade alone and we die alone. It sounds depressing but its true. By trading
alone, I mean we are solely responsible for our P&L, our trade selection, our risk management and
so on.
Further to this we all see things differently. That means our views on everything to do with trading
are different from the guy to your left and the guy to your right.
In the next section we will look at some trading set ups. They are designed to give you some basic
pattern ideas. However, being an active day trader is not about systemising an approach. Its about
being opportunistic. Its about finding where and what the opportunities are.
Looking at DV01s for example is one step towards being able to identify opportunities in related
markets. Here are a few others ideas on...

Part 5: Trading Setups

I cringe when I see the term setup. Its very much a retail term. That is you see it in all the books
written for part-time and beginner traders. At times, it seems to be used as a lure to sell a book or a
course. It suggests trading is as simple as knowing a few patterns.
That said, here we have a section on setups. However, rather than write these setups down and
memorise them, think of them as ideas or ways to look for a trade. If anything, they will help you
think about trading these markets from an opportunistic kind of way rather than a systematic. Think
about it.

A. Always the Last to Know

Here is a pattern that can often play out on the short term charts 1 minute, 2 minute etc. It is a
brilliant example of why you would trade a slower market such as the Aussie bonds versus the wellestablished US Treasuries.
One way to look at it is that the Aussie bonds will behave in their own way, but only if the US
Treasuries let them. In this example we have the US Treasuries all drifting higher over the day. There
was a point where all three stopped and found some resistance (the red lines in the diagram). At the
same time, the Aussie 10yr bonds pulled back a few ticks for no particular reason (the circled area).
If we call it a 0.030 dip, that is3 basis points an equivalent of about 7.5/32nds in the 10yr Tnote
but the Tnote did not move!
The clear trade to make is to be long the Aussie bonds for a move worth at least a couple of ticks. In
this example, the Aussie bonds had already dipped from their highs when the Treasuries came back
a few ticks. That meant minimal downside in the Aussie market as the 10s did not move further
down. Then, before the Treasuries even broke to a new high, the Aussie market rebounded and
showed a trade that was a few ticks onside.

As with other setups here, this setup was not suggesting we were in for a large move. It provided a
very low risk trade good for a couple of ticks. Given the large ticks size in the Aussie bonds however,
a few ticks is a good trade

B. The DV01 Gapper

One really great thing about futures markets is that they are not open 24 hours per day. Many are
almost 24 hours, but not 24 hours. When we are looking at markets trading in different countries
(e.g. The Aussie bonds and US Treasuries) that means we can see one market open while the other
isnt. Even if it just for 30 minutes, that can provide an opportunity.
When trading the Aussie bonds and US Treasuries, this can create gap trades, particularly when the
Aussie is closed and the US market is open and makes a decent move.
Here is a super simple example: Market A trades around the clock. Market B is closed for an hour at
the end of each day. The two markets are highly correlated. For every 2 ticks Market A moves,
Market B tends to move 1 tick.
At the end of one particular session we had the following closes:

Market A

Market B

Now suppose over the next hour, while Market B is closed, Market A rallies 30pts just ahead of the
Market B reopening. We would then have:
60 mins later

Market A

Market B

Market B is about to re-open. Where would you expect it to open. Given its 2:1 correlation, you
would expect it to open around 91.15, 15pts higher.
Excluding any other influential factors, the trade to make would be buying an open up to 91.14 or
selling an open 91.16 or above.
That margin (i.e. one tick below and one tick above, in this case) will vary from market to market and
in different trading conditions, but you get the idea.
So how do we do this in notes and bonds? Aussie and US markets are quoted differently, so we can
use prices only a rough estimate. A more accurate measure is to use DV01 or basis points.
At the time of the Aussie close, we have the following prices:



Market B

While the Aussie market was closed we see the Tnote trade lower by 10/32.

At reopen


Market B

Now, from previous pages, we know that one basis point in the Tnote is close enough to 2.5/32nds
and one basis point in the Aussie 10s is 0.01. Assuming then the Aussie market will follow the US
market lower on the open, we should see an opening price of 96.98, 4 basis points lower.
There have been many situations where for whatever reason the Aussie market has not followed the
US market basis point for basis point. Excluding a large move in the currency however, the market
can often return to that expected open level pretty quickly.
Essentially the trade is to take a position in the Aussie market on reopen with the expectation that it
will follow the US market in terms of basis points. It is that closing period that can get the two
markets out of line. More often than not, the first few minutes (but sometimes longer) will see
Key points with this trade:

More opportunity comes when the markets have been volatile BUT they can still pop up
when things are quiet. It pays to calculate where the markets should reopen every day and
place orders accordingly.
The Aussie bond markets have a 10 minute auction or pre-open where you can
place/cancel orders but not get filled. After calculating your expected open, why not place
orders above and below in the auction? Sometimes that split second blip on open can get
you in and out of a very quick trade.

C. Yield Curve High Jinx

Here is one that is hard to show in images, but it is a trade that I have done a couple of times now
and has surprisingly worked quite well. The first time I made this trade, I was being cheeky and just
trying something on. It worked a treat, but I did realize its all in the timing.

If we look at the 5yr, 10yr Tnotes and the Tbond, we have markets where everyone watches the
Tbonds and the 10yr note and that 5yr is like the annoying little brother that just follows along.
That said, people dont ignore the 5yr note. There is still a strong correlation between it and the rest
of the curve, both from click traders and algorithms/autospreaders.
This is the key to the setup: there are times when the 5yr can trigger movement in the others. The
best trades come from this when the market is vulnerable to a certain move such as stops going off
above a high or below a low.
The specific example I have seen played out a few times now is when all three markets were trading
near their intraday highs and the 5yr note went offer over the high while the other two were within
a few ticks off the equivalent high.
One trade to make is to get long the Tbond (having a large tick size) and then use the 5yr note to
make a new high and see if it triggers a move in the bond.
The 5yr note has a small tick size of $7.815. This means that hitting into the offer with a one lot will
not cost you much money if you are wrong on the trade.
So the idea here is to make a new high in the 5yr note while holding a long position in the bond. If it
works, and the new print in the 5yrs helps push the 10s and 30s higher, its highly unlikely that it will
be for more than a few ticks in each. That being the case, have your offers in each market a just few
ticks away ready for an exit.

D. Resting Orders on Data

Trading data can be tricky, but can also be quite lucrative if you can get filled at a good price. Often
(but not always) you will see orders that are left in the system heading into data. This gives you
something to hit into if the data offers a trade opportunity.
For example, seconds before a recent RBA announcement on rates, we had the Aussie 10s and 3s
looking like this:

There was a 305 lot on offer in the 10s and just over 700 in the 3s. Heading into the data, these
numbers were not moving. This suggests that order will be there regardless of the RBA decision on
Whats the setup? The overall opinion on what the RBA was about to announce was split 50:50. They
were either going to cut or leave rates unchanged. That meant, the market was about to move in
one direction or the other. The chances of the market holding flat were one in a million.
With a quick trigger finger, hitting into those offers if the RBA announced a cut would be the trade to
As it turned out the RBA left rates steady and there was an immediate gap lower. There was the
potential to get short, but not immediately. If there were resting orders on the bid side, there would
have been a good opportunity to hit market as quickly as possible.
These trades do not present themselves on every data release, but they come up often enough.

E. Data Pullbacks
When trading a reaction to data, quite often a market such as the Aussie 10yr bonds will give you
more than one chance to get a trade on.
Following on with the RBA announcement as discussed above, the decision not to cut rates triggered
a sell-off in the Aussie bonds. What was interesting was the move in the 10yr bond.
After the initial reaction, which happened too fast to click into, the bonds pulled back a touch, giving
an opportunity to get short before the next move lower (circled).

At the time, how do we know it will move lower again? Well we dont. The first point to make
however, this is a falling knife market. We know not to try to catch the falling knife. That is, we
dont fade the move that is the immediate reaction to data. For the first minute or so, it should be a
short position or nothing.
As the market paused and traded up a few ticks, the thing to ask is whether this is the end of the
move or part of a continuation. The answer lies in looking to other markets for a little perspective. In
this instance, the Aussie 3yrs were down 7-8 points on the day when the Aussie bonds were all up a
tick or two.
There is no way the market would not continue into negative territory when a) we have just had
bearish news and b) its 3yr counterpart is down 7-8 ticks. You could also add that the market was
still a few ticks away from the nearest technical support level if you look at that sort of thing.
That little pullback was a perfect set up and a great opportunity to get short and ride it for a few
more ticks.
These types of pullbacks happen often enough to take advantage of and at the very least if you are
wrong, waiting for the pull back to enter the market still gives you a pretty low risk trade compared
with hitting market in the direction of momentum.

F. Other setups
All of these set ups simply describe how these markets behave. If you think about it, that is all a
setup is an understanding of how a market behaves so much as to find repeatable patterns.
Exactly how a setup unfolds is always changing. One day, a market may be following the Tnote
exactly, the next it might be doing the opposite. Sometimes there are identifiable reasons for this
and other times there aren't.

Reading the market is not about applying a bunch of rules that some Guy came up with. Its about
spending enough time in front of the screen so you can understand how a market is behaving and
spot the opportunity.

More information
Book: Trading STIR Futures by Stephen Aikin
CME Treasury Futures General Info:
CME Treasury Futures Duration and DV01 Tool:
Measuring the price sensitivity of U.S. Treasury Futures doco:
Calculating the Dollar Value of a Basis Point doco:

About the Author

Guy Bower is a trader, author, analyst and mentor in the futures markets. He runs online training
and development at Propex Derivatives in Sydney Australia.

Contact details
Guy Bower

The information in this document and related documents and communication is intended for inhouse educational purposes only and does not constitute advice. Redistribution of the material
without prior permission is prohibited.