What Is The TUT Spread?

The TUT spread, shorthand for the two's over tens spread, is the difference between the 10-year bonds and the 2-year notes. This spread is considered an important gauge regarding the current shape of the yield curve. Traders will typically keep an eye on the TUT spread and oftentimes use it as a signal of where interest rates may be headed.

A yield curve plots the yields (aka interest rates) of bonds over the course of their lifetime (typically from 3 months to 30 years). If you’re not already familiar, you can read more about yield curves here.

Do You Expect The Yield Curve To Steepen Or Flatten?

When you trade the yield curve, you typically have an assumption of whether you think the yield curve will steepen, or flatten.

A steepening yield curve is one where the yields of the shorter term maturity bonds is moving farther away from yields of the longer term maturity bonds, thus making the steepness of the curve increase.

A flattening yield curve is one where the yields of the shorter term maturity bonds are moving closer to the yields of the longer term maturity bonds, thus making the curve flatten out.

Choosing A Flattening Yield Curve Trade Or A Steepening Yield Curve Trade

If you expect that the yield curve will be flattening over the duration of the trade your placing (this will be dependent of the expiration month of the contracts that you are trading), then you will want to sell the TUT spread.

If you expect that the yield curve will steepen over the duration of the trade, then you will want to buy the TUT Spread.

Flattening TUT Spread (Selling The TUT Spread)

If you expect the TUT spread to flatten, you will sell the spread. Therefore, you will be selling the front leg of the trade (the 2-year notes) and buying the back leg (the 10-year bonds).

Steepening TUT Spread (Buying The TUT Spread)

If you expect the TUT spread to stepen, you will buy the spread. Therefore, you will be buying the front leg of the trade (the 2-year notes) and selling the back leg (the 10-year bonds).

What You Should Know About Trading The TUT Spread

When trading the TUT spread, it is important to understand how to properly weight the trade so that the values for each side of the spread are as equal as they can be. To do this, we first need to know the notional values of the contracts, and then, we need to find the dollar value of a basis point (DV01) so we can make sure that the trade is weighted equally in that dimension as well (if you’re familiar with stock options, you can think of DV01 as your delta).

TUT Spread Notional Value
The notional value of the 2-year notes (/ZT) at maturity is $200,000 and the notional value of the 10-year bonds (/ZN) is $100,000. If it were only notionally weighted, then the spread would be 2:1. However, we want to make the trade DV01 neutral so we will incorporate that as well.

TUT Spread Dollar Value Of A Basis Point
Unless you want to deal with hand calculations and long formulas, the DV01 value can be calculated using the calculator found here. The DV01 values for the TUT spread at the time of the trade placed in the video were:
/ZT = 37.31
/ZN = 77.92

Given the DV01 values, we can use them, along with the notional values of the two futures contracts, and multiply them together to get what is referred to as the spread ratio.

Creating The Spread Ratio
The spread ratio for the TUT Spread is calculated using the formula below.

(2-year DV01 * Notional Value of 2-Year Notes) / (10-year DV01 * Notional Value of 10-Year Bonds)

If we want to plug in the DV01 and notional values from above, it would look like this: (37.31 * $200,000) / (77.92 * $100,000) = 7,462,000/7,792,000 = .95

The hedge ratio would be .95, which we would round up to 1. Therefore, for the TUT spread, we will use 1 /ZT contract and 1 /ZN Contract.

Strategies: TUT Spread (Twos Over Tens Spread)
Products Discussed In This Episode: /ZT, /ZN