Bond Futures: How Treasury Bond and Eurodollar Futures Work

Treasury Futures Contract Specifications

Each Treasury futures contract has standardized specifications. The 10-year Treasury note (ZN) has a notional value of $100,000 face value. The 30-year Treasury bond (ZB) has a $100,000 notional value. The 5-year note (ZF) and 2-year note (ZT) have $100,000 and $200,000 notional respectively. Tick sizes vary: ZN and ZB move in 1/32 of a point ($31.25 per tick for ZN, $31.25 for ZB). Ultra variants offer finer pricing. Contracts are quoted as a percentage of par: a ZN price of 104-16 means 104 and 16/32 (104.50% of par). Trading hours are nearly 24 hours on CME Globex. Contract months follow the quarterly cycle (March, June, September, December). Settlement is physical delivery of eligible Treasury securities. The delivery process is complex due to the conversion factor system -- sellers can deliver any eligible bond issue, with adjustments made via conversion factors. Delivery occurs over a delivery month window, with the exact timing chosen by the seller (short position). T-bills, notes, and bonds explained →

Conversion Factors and Cheapest-to-Deliver

The conversion factor system allows Treasury futures to accept delivery of multiple bond issues with different coupons and maturities. Each eligible bond has a conversion factor that adjusts its invoice price to make it comparable to the notional 6% coupon bond that the futures contract represents. The conversion factor is calculated based on the bond's coupon and remaining maturity. The seller (short position) chooses which bond to deliver and will select the bond that is cheapest to deliver (CTD). The CTD bond is the one that minimizes the cost of delivery: the bond's cash price minus the futures price times the conversion factor. The CTD bond changes over time as bond prices move and as the futures contract approaches expiration. Most of the time, the CTD is the bond with the lowest coupon among eligible issues (because lower-coupon bonds trade at a discount, making them cheaper to deliver). The CTD concept is critical for pricing Treasury futures -- the futures price tracks the CTD bond, not the general bond market. Understanding CTD dynamics is essential for hedging and arbitrage. Bond duration and price sensitivity →

Eurodollar and SOFR Futures

Eurodollar futures (ticker GE) were once the most actively traded futures contract in the world, based on 3-month LIBOR interest rates. They are being phased out after the LIBOR scandal and transition to SOFR (Secured Overnight Financing Rate). SOFR futures have replaced Eurodollar futures as the primary short-term interest rate futures. The two main SOFR futures contracts are: 1-month SOFR futures (SR1) based on the average daily SOFR during the contract month, and 3-month SOFR futures (SR3) based on the compounded SOFR over a 3-month period. These contracts are used to hedge short-term interest rate exposure, express views on Federal Reserve policy, and construct yield curve trades. Pricing is based on 100 minus the expected interest rate. If the market expects a 5.00% SOFR rate, the future trades at 95.00. A basis point move in rates equals $25 for 3-month SOFR futures and $41.67 for 1-month SOFR futures. These contracts are essential for banks, money market funds, and anyone exposed to short-term interest rates. Treasury bill investing →

What are bond futures and how do they work?

Bond futures are standardized exchange-traded contracts that derive their value from underlying government bonds or interest rates. A Treasury futures contract obligates the seller to deliver eligible Treasury securities at expiration, with the exact bond chosen by the seller. The price of bond futures reflects the market's expectation of future interest rates: when rates rise, bond futures fall; when rates fall, bond futures rise. Bond futures are used for hedging interest rate risk (selling futures to protect a bond portfolio), speculation (taking directional views on rates), and yield curve trading (spread strategies across different maturities). The conversion factor system ensures that any eligible bond can be delivered, with adjustments for coupon and maturity differences. Bond futures settle physically, meaning actual bonds change hands at expiration. The market is highly liquid, with deep order books and tight bid-ask spreads in the front-month contracts. Yield curve inversion explained →

How do you hedge a bond portfolio with bond futures?

Hedging a bond portfolio with bond futures involves calculating the hedge ratio based on duration. The process: determine the portfolio's dollar duration (DV01 -- the dollar change per 1 basis point move in yield). Calculate the futures contract's DV01 (based on the CTD bond's modified duration). Divide the portfolio DV01 by the futures DV01 to get the number of contracts. If you own bonds and expect rates to rise (bond prices to fall), sell futures. If rates rise, the short futures position generates profits that offset the bond portfolio's losses. The hedge ratio must be adjusted periodically because duration changes as time passes and yields move. For precise hedging, traders use yield beta -- the historical relationship between the futures yield and the portfolio yield. Cross-hedging (using T-note futures to hedge corporate bonds) requires additional adjustments for credit spread risk. The hedge is never perfect due to basis risk between the futures and the actual bonds, but it provides substantial protection against adverse rate moves. Portfolio hedging with futures →

What is the cheapest-to-deliver bond in Treasury futures?

The cheapest-to-deliver (CTD) bond is the eligible Treasury security that minimizes the seller's cost of delivery in a Treasury futures contract. The cost of delivery is: bond cash price minus (futures settlement price times conversion factor). The seller will naturally deliver the bond with the largest difference (cheapest). CTD is typically the bond with the lowest coupon among eligible issues because lower-coupon bonds trade at a discount to par, making them cheaper to deliver relative to the futures invoice price. However, the CTD can change over the life of the futures contract as bond prices move, yields change, and new bonds are issued. When the yield on eligible bonds is above 6%, CTD tends to be the longest-maturity bond (because higher yields increase the value of the delivery option on longer bonds). When yields are below 6%, CTD tends to be shorter-maturity bonds. The CTD bond's price is the primary driver of the futures price, and the difference between the futures price and the CTD forward price is the delivery option value. Bond yield and price relationship →

What trading strategies use bond futures?

Bond futures support a wide range of trading strategies. Directional trades: buy or sell futures based on interest rate views. If you expect the Fed to cut rates, buy ZN or ZB. Curve trades: use spreads (e.g., buy ZN, sell ZB) to trade yield curve steepening or flattening without taking directional rate risk. TED spread: trade the difference between Eurodollar/SOFR futures and Treasury futures to express views on credit risk. Butterfly trades: a three-legged spread on the yield curve (short maturity vs intermediate vs long) focusing on curve curvature. Duration hedging: short futures to hedge bond portfolios or long futures to extend duration without buying bonds. Arbitrage: basis trades exploiting mispricing between futures and the CTD bond. Roll trades: capturing value as futures approach expiration and the CTD rolls. The deep liquidity of bond futures allows execution of large positions with minimal slippage, making them preferred tools for institutional investors and active traders. Duration and convexity explained →

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