Leveraging U.S. Treasury Bonds Using The Futures MarketAdvisor Perspectives
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
In my prior article, I showed why leveraged U.S. Treasury bonds make sense as an ordinary investment – one that rivals the returns of equities but with smaller drawdowns. This article converts theory into practice using the universally accessible futures market, without borrowing money.
My goal is not to set the reader out to do it alone, but rather to demystify the mechanics and show it is possible.
What are futures?
Futures contracts seem more complicated than they really are. Their name and definition imply that traders have an opinion about an asset’s price at a particular date in the future. Not so. Most futures are simply a way to buy and sell assets that are otherwise cumbersome. That’s it. They react to the same information the underlying asset reacts to, at the same time and in the same proportion.
Futures first arose to facilitate the trading of commodities. The innovation was to move the settlement date of a trade (day when money and product are exchanged) out beyond the usual one or two days, to 90 or more days (the future), and then to use a single settlement date for a given window of time (the delivery date in futures parlance). Moving the settlement day far away allowed traders to buy and sell assets that were big and heavy (think oil, cattle, gold) without immediately having to worry about delivering them. Using a single settlement date created a tradeable market in a single contract. Traders could get into and out of the contract before it settled – never having to pay for, or take delivery of the commodity – instead just participating in changes of its price.
That is the crucial mechanism of futures. Consider the example of buying and selling a share of stock on the same day. When those trades settle, the debit from the buy will net against the credit from the sell and only the profit or loss will be left in the account. Because the position was flat by the end of the day, the trader could’ve bought and sold more shares than they had capital for (leverage), as long as they could cover any possible loss. Futures have formalized this idea of being flat by the settlement date. Since position sizes aren’t limited by how much you can purchase, futures exchanges restrict them with margin requirements – sized in proportion to recent price changes, not the value of the asset.
U.S. Treasury futures
It is this ability to leverage without borrowing money that has driven futures to expand beyond the “big and heavy” to financial assets – so-called financial futures. Financial futures are popular because financing the underlying assets is cumbersome. It is doable, but you need access to the right markets, you need them quickly, and often with big numbers. Financial futures track several currencies, bonds and stock indices. Among them is the behemoth U.S. Treasury futures market.
You would be forgiven for thinking U.S. Treasury futures are an obscure corner of finance. Surprisingly, they are the main event. Trading volume in them is the highest of any category of futures contract (see chart below).
Also, U.S. Treasury futures have been around for a long time, trading now for 41 years. Below is a summary of the six contracts offered, when they began trading, and, historically, the most conservative leverage levels allowed; more leverage than you might think.
Read the full article here by Eric Hickman, Advisor Perspectives