Bond Futures

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What Are Bond Futures?

Bond futures are financial derivatives that obligate the contract holder to purchase or sell a bond on a specified date at a predetermined price. A bond futures contract trades on a futures exchange market and is bought or sold through a brokerage firm that offers futures trading. The terms (price and the expiration date) of the contract are decided at the time the future is purchased or sold.

Bond Futures Explained

A futures contract is an agreement entered into by two parties. One party agrees to buy, and the other party agrees to sell an underlying asset at a predetermined price on a specified date in the future. On the settlement date of the futures contract, the seller is obligated to deliver the asset to the buyer. The underlying asset of a futures contract could either be a commodity or a financial instrument, such as a bond.

Key Takeaways

  • Bond futures are contracts that entitle the contract holder to purchase a bond on a specified date at a price determined today.
  • A bond futures contract trades on a futures exchange and is bought and sold through a brokerage firm that offers futures trading.
  • Bond futures are used by speculators to bet on the price of a bond or by hedgers to protect bond holdings.
  • Bond futures indirectly are used to trade or hedge interest rate moves.

Bond futures are contractual agreements where the asset to be delivered is a government or Treasury bond. Bond futures are standardized by the futures exchanges and are considered among the most liquid financial products. A liquid market means that there are plenty of buyers and sellers, allowing for the free flow of trades without delays.

The bond futures contract is used for hedging, speculating, or arbitrage purposes. Hedging is a form of investing in products that provide protection to holdings. Speculating is investing in products that have a high-risk, high-reward profile. Arbitrage can occur when there’s an imbalance in prices, and traders attempt to make a profit through the simultaneous purchase and sale of an asset or security.

When two counterparties enter into a bond futures contract, they agree on a price where the party on the long side—the buyer—will purchase the bond from the seller who has the option of which bond to deliver and when in the delivery month to deliver the bond. For example, say a party is short—the seller—a 30-year Treasury bond, and the seller must deliver the Treasury bond to the buyer at the date specified.

A bond futures contract can be held until maturity, and they can also be closed out before the maturity date. If the party that established the position closes out before maturity, the closing trade will result in a profit or a loss from the position, depending on the value of the futures contract at the time.

Where Bond Futures Trade

Bond futures trade primarily on the Chicago Board of Trade (CBOT), which is part of the Chicago Mercantile Exchange (CME). Contracts typically expire quarterly: March, June, September, and December. Examples of underlying assets for bond futures include:

  • 13-week Treasury bills (T-bills)
  • 2-, 3-, 5-, and 10-year Treasury notes (T-notes)
  • Classic and Ultra Treasury bonds (T-bonds)

Bond futures are overseen by a regulatory agency called the Commodity Futures Trading Commission (CFTC). The role of the CFTC includes ensuring that fair trading practices, equality, and consistency exists in the markets as well as preventing fraud.

Bond Futures Speculation

A bond futures contract allows a trader to speculate on a bond’s price movement and lock in a price for a set future period. If a trader bought a bond futures contract and the bond’s price rose and closed higher than the contract price at expiration, then the trader has a profit. At that point, the trader could take delivery of the bond or offset the buy trade with a sell trade to unwind the position with the net difference between the prices being cash-settled.

Conversely, a trader could sell a bond futures contract expecting the bond’s price to decline by the expiration date. Again, an offsetting trade could be input prior to expiry, and the gain or loss could be net settled through the trader’s account.

Bond futures have the potential to generate substantial profits since bond prices can fluctuate widely over time due to varying factors, including changing interest rates, market demand for bonds, and economic conditions. However, the price fluctuations in bond prices can be a double-edged sword where traders can lose a significant portion of their investment.

Bond Futures and Margin

Many futures contracts trade via margin, meaning an investor only needs to deposit a small percentage of the total value of the futures contract amount into the brokerage account. In other words, the futures markets typically use high leverage, and a trader does not need to put up 100% of the contract amount when entering into a trade.

A broker requires an initial margin and, although the exchanges set minimum margin requirements, the amounts can also vary depending on the broker’s policies, the type of