Yields on US Treasury 30 year Bonds and Ten Year Notes recently hit all time lows. The Yield Curve is flattening. The spread between 10-year and 2-year Notes is known as the TUT spread (for Twos Under Tens) and was just at 0.82% which is a level not seen since 2008 (a graph of the spread was displayed showing lows below zero and highs near 3%). Is there a way for us to take advantage of these levels to put on a good trade? Pete Mulmat, our Futures expert, joins the guys to discuss the spread, put things in context and offer a trade idea you might want to try.
Yields and Bonds have an inverse relationship. Because of that the spread is more commonly displayed as /ZN - /ZT and Pete displayed a graph of the spread. He also displayed a table with their contract specifications. Of special note is that the two year has twice the notional value at par as does the ten year. Despite this the spread is traded 1:1 because of their DV01 calculations. The Best Practices from June 13, 2016: DV01 of What? which featured a guest appearance from Pete explains DV01 in depth. Pete had a table prepared which showed that if you were expecting the spread to tighten you would sell the spread and that meant selling the 2-year and buying the 10-year. Whatever you are doing in the spread you are doing in the shorter duration future and the opposite in the longer duration future. This is not the same as the duration we speak of when trading options.
Pete then used a table to lay out his basic trade idea. It was buying the spread (so he is expecting the Yield Curve to steepen). As noted above the spread is 1:1 despite the differences in notional values. The prices, contract months, symbols and margin required for each leg of the spread plus the total buying power reduction. A graph gave an indication of how much the spread can move over a 10 day period. A final table showed how to synthetically mimic the trade using futures options, specifically, using Vertical Call Spreads.
Watch this segment of Closing the Gap - Futures Edition with Tom Sosnoff, Tony Battista and our Futures expert Pete Mulmat for a better understanding of the Yield Curve, the Spread between Two Years and Ten Years and a trade idea you may want to try along with a variation using options with a defined risk.
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