Futures
The most liquid rates instruments on Earth - and the basis trades that nearly broke the market.
The Day the Basis Blew Up
March 12, 2020. Hedge funds had $500+ billion in Treasury basis trades. Long cash bonds, short futures, pocket the spread. "Risk-free arbitrage" they called it.
Then COVID hit. Repo markets seized. Margin calls exploded. Everyone tried to unwind at once. The "risk-free" trade turned into a massacre. Some of the world's largest hedge funds - Citadel, Millennium, Bridgewater - faced existential margin calls in a matter of days.
The basis trade is elegant in theory: cash bonds should trade close to futures prices (adjusted for delivery). When they diverge, arbitrage brings them back. But in March 2020, there was no one left to arbitrage. Dealers couldn't hold inventory. Prices disconnected from reality.
The Fed bought $1.6 trillion of Treasuries in weeks to restore order. Understanding futures - and the basis - isn't optional. It's survival.
Treasury Futures: The Contracts
Six Treasury futures contracts span the yield curve. Each has different characteristics, durations, and use cases. Click to explore:
10-Year Note (ZN)
~$75/contract DV01The most liquid futures contract in the world.
Conversion Factors and CTD
Treasury futures can be delivered with any bond within the deliverable window. But different bonds have different coupons and maturities. How do you make them equivalent?
Conversion Factor (CF)
Each deliverable bond has a conversion factor - a multiplier that adjusts the futures price to account for the bond's coupon and remaining life. It's calculated assuming a 6% yield.
Cheapest-to-Deliver (CTD)
The cheapest-to-deliver is the bond that's cheapest to deliver into the futures contract. The short position always delivers the CTD because it minimizes cost.
Warning: CTD can switch suddenly when yields cross threshold levels. This changes the effective duration of your futures position overnight.
SOFR and Fed Funds Futures
Short-term rate futures let you trade Fed policy expectations directly. No bonds, no duration - just pure rate bets.
3-Month SOFR
SR3Hedging short-term rates, expressing Fed views
1-Month SOFR
SR1Fine-tuning front-end exposure
Fed Funds Futures
ZQTrading FOMC meeting outcomes directly
Reading Fed Funds Futures
Fed Funds futures price at 100 minus the expected rate. If the January contract is at 95.25, the market expects the Fed Funds rate to average 4.75% that month.
You can back out the probability of rate hikes/cuts at each FOMC meeting by comparing consecutive contracts. This is how "Fed pricing" gets calculated.
The Basis: Cash vs Futures
The basis is the difference between the cash bond price and the futures price (adjusted for conversion factor). It's the heart of cash-futures trading.
Gross Basis
Raw difference between cash and converted futures
Carry
Net cost/benefit of holding the cash bond to delivery
Net Basis
True economic value of the basis trade
Implied Repo
The financing rate implied by the basis
What Drives the Basis?
- Repo rates: Higher repo = higher financing cost = wider basis
- Supply/demand: Heavy futures selling = cheaper futures = wider basis
- Delivery optionality: Short has timing and CTD options = basis premium
- Liquidity: Illiquid cash bonds trade at discounts = wider basis
Historical Examples
Learn from the trades that went wrong (and right). Select an event:
The Basis Trade Blowup
Basis widened 50+ bps in daysThe Setup
Hedge funds had built massive basis trades: long cash Treasuries financed in repo, short Treasury futures. The trade relied on stable financing and convergence at delivery.
What Happened
COVID panic hit. Repo rates spiked. Margin calls forced liquidation. Everyone tried to unwind simultaneously. Cash bonds sold off MORE than futures, blowing out the basis.
Futures DV01
Unlike cash bonds where DV01 depends on price and duration, futures DV01 is simpler - it's driven by the CTD bond's characteristics and the conversion factor.
Cash vs Futures: Same DV01, Different Capital
Key difference: Futures require only margin, not full funding. But margin can increase during volatility, and you face daily mark-to-market.
Build a Futures Position
Trade Legs
Combined Position
Payoff Profile
P&L across parallel yield curve shifts (all tenors move equally):
Risk Summary
Position is long duration (+$8K DV01). Profits when rates fall, loses when rates rise.
Trade Examples (Simple)
Three futures trades explained simply, with funding context:
Example 1: The Futures Long
You think rates are going down. Instead of buying $10M of 10Y cash bonds, you buy 100 ZN (10Y) futures contracts.
Cash bond route: You'd need $10M cash, or finance via repo with ~$500K margin and pay 5.3% financing. Futures route: You post ~$250K initial margin. No daily financing cost - the funding is embedded in the futures price. But you face daily mark-to-market: profits are credited, losses are debited to your margin account.
Rates fall 25bps.
100 contracts x $75 DV01 x 25bps = +$187,500
You got 10Y exposure with 4% of the capital. No repo, no daily interest payments. Just margin and daily settlement. This is why hedge funds love futures.
Example 2: The Basis Trade
You buy $10M of the CTD cash bond, short 100 ZN futures. The net basis is -0.15 (cash is cheap). You expect convergence at delivery.
Long cash leg: Finance $10M via repo at 5.3%, post $300K margin. Short futures leg: Post $250K futures margin. Total capital: ~$550K. You earn the bond's 4% coupon, pay 5.3% repo. Net carry is negative, but you're betting on basis convergence of 15+ ticks to make up for it.
Normal convergence: basis goes from -0.15 to 0 at delivery.
Basis gain: $10M x 0.15% = +$15,000. Minus negative carry over 45 days. Net: ~+$5,000
You're not betting on rates - you're betting on cash and futures converging. Works great until repo markets seize and you can't finance. Then you're forced to sell into a hole (see March 2020).
Example 3: The Calendar Spread
You sell 100 ZNH4 (March) and buy 100 ZNM4 (June). You're betting the roll will cheapen (back month gains relative to front).
Calendar spreads have massively reduced margin because the legs offset. Instead of $500K for 200 outright contracts, you post ~$50K for the spread. The exchange recognizes you're not taking directional risk. This is pure roll/financing bet.
Front month (March) rolls off expensive, back month (June) becomes the new front. Roll spread narrows from -0.20 to -0.10.
100 contracts x $15.625/tick x 6.4 ticks = +$10,000
You're trading the shape of the futures curve, not rates. Roll spreads reflect financing expectations. If you think repo will drop (Fed cutting), the roll should cheapen. Capital efficient way to trade Fed views.
Futures vs Cash: Funding Context
The key difference between futures and cash isn't the exposure - it's the funding.
Cash Bonds (via Repo)
- Financing: You borrow money daily at repo rate
- Carry: Coupon - Repo = your daily P&L from holding
- Capital: Full notional (or ~5% margin if repo financed)
- Counterparty: Repo dealer - they can refuse to roll
- Flexibility: Can go on/off special, choose term
Risk: Repo can be pulled. Rates can spike. You can be forced to sell.
Futures (Margin-Based)
- Financing: Embedded in futures price (no daily interest)
- Carry: Futures price already reflects expected financing
- Capital: Initial margin only (~2-3% of notional)
- Counterparty: Clearinghouse (virtually no credit risk)
- Flexibility: Standardized, liquid, but roll costs exist
Benefit: Can't be forced out by repo. But margin can increase in volatility.
When to Use Each
- You want clean rate exposure without repo hassle
- Capital efficiency is critical (hedge funds, prop shops)
- You're trading short-term and want to avoid roll costs
- You need counterparty credit protection
- You want the actual bond (for delivery, collateral)
- You can access cheap or special financing
- You're basis trading or need specific issues
- You want coupon income (not rolled into price)