Market: Treasury Interest Rate

COSMIC:  The first thing that comes to mind when thinking of investing is stock. After all, stocks are exciting and have been popularized for the masses by the media.  Market swings are scrutinized in newspapers and covered by evening newscasts. Stories of investors gaining great wealth in stock engender novices to engage.  But great stock wealth stories are similar to the huge well lighted casino manqué about the recent slot machine winner… all done to gather the crowd.

Bonds, interest rate derivatives, on the other hand, lack sex appeal. It’s because futures are dressed up to conceal their true beauty. The lingo seems arcane and confusing to the novice. Plus, bonds are boring - especially during raging bull markets -- seemingly to offer insignificant reward compared to stocks.

However, all it takes is a bear market to remind investors of the virtues of the bond's safety and stability. In fact, for many investors it makes sense to have a significant portion of their portfolio invested in bonds.  The tutorial in the link below will help you appreciate whether bonds are right for you.

Bond Basics: What are bonds?
The salient ingredient in bonds is interest earned and value of rate.  We trade interest rates via futures on U.S. Bonds and Notes. Our mentor concentrates on trading what he considers to be the best trending future.  Sometimes it’s beans.  Other times it’s oil.  But, there are many instances where U.S. Treasuries trend in a range for days and weeks… lacking the jerking volatility of the Index Futures and Currencies. Although this volatility may work against you, it may also work in your favor. For example, recently, the 30-year bond traded up from June 2006 peaking out in January 2007. Had somebody entered just one contract long near the low near 104 and exited around its high of 121 in January 2007, This illustrates the longer-term trending nature of the Bond market that we believe may be taken advantage of by buying into an upward moving market.  However, as with any opportunity for potential profit, the risk of being on the wrong side of a trending market would remain and a customer’s tolerance for the risk of losing his or her investment should be assessed before entering any trade.

But, you must take time to learn all you need to know to effectively trade Interest Rate Futures. The uninformed masses incorrectly believe home interest rates are controlled by the highly publicized overnight bank rate that Chairman Ben Bernake and the regional Federal Reserve Chiefs around the U.S. control via the Federal Open Market Committee [FOMC].  Keep in mind that, generally, the rule of thumb for 30 year fixed mortgage interest is the 30 year bond rate +1.

Corporate and Government Bonds are interest rate sensitive, and their prices move inversely to interest rates.  This has led to the growth within interest rate futures and the development of futures contracts across the yield curve.  The yield curve is extremely important for bond portfolio investing.  In finance, the yield curve is the relation between interest rate (cost of borrowing) and time to maturity of the debt for a given borrower in a given currency. For example, the current U.S. U.S. Dollar interest rate paid on U.S. Treasuries for various maturities is closely watched by every trader. Rates are plotted on a graph, which is informally called the "yield curve." More formal mathematical descriptions of this relation are often called the term structure of interest rates yield curve.

Interest Rate Futures can be interpreted as forward rates of interest.  For example, the yield of the June 08, T-bill futures contract is the forward rate of interest for a 90 day T-bill that starts in June and expires in August.  The most widely traded short-term interest rate contract is the Eurodollar (ED).  Eurodollars are U.S. dollars on deposit in foreign banks, and expire every three months.

Typical yield curves start with short-term interest rate products and gradually increase to longer term.  For example, the fed funds 30 day overnight borrowing rate would be the shortest interest rate product, then tomorrow next rate, one month, three month, two year, three year, four year, five year, seven year, ten year, and finally, 30 year bond.  This collection can come from cash products, futures products, and swaps.

It is our intention to look for changes within the slope of the yield curve and take spread positions along the yield looking to take advantage of the changing slope due to the effect of interest rates on price of the underlying.  Options will come into play. Some popular spread positions are:

TED Spread – Involves the T-Bill futures contract and the Eurodollar contract.  Traders who take positions in this type of spread are speculating changes in the relative riskiness of the Eurodollar deposit.

NOB Spread – This strategy uses notes and bonds. A trader might buy T-Bond futures and simultaneously sell T-Note futures.  Traders that put on this type of spread are anticipating a shift in the yield curve.  Longer term rates are traditionally higher than shorter term; however, the differential between them fluctuates continuously.

LED Spread – This is when a simultaneous position is taken with LIBOR ( London international bank offering rate) and Eurodollars.  The LIBOR is a one month rate and similar to the 30 day Fed Funds rate.  Traders take positions if they speculate the slope of the yield curve to change because of apparent arbitrage in forward rates associated with implied yields.  

DISCLOSURE: The High Degree of Leverage Often Obtainable in Commodity Trading Can Work against You As well As for You. Use of Leverage Can Lead To Large Losses As Well As Gains.