Bond Futures

Bond Futures: What They Are, How They Work, and How to Buy Them

Key takeaways
* Bond futures are exchange-traded derivative contracts obligating the buyer or seller to transact a specified bond at a preset price on a future date.
* They’re used for hedging interest-rate risk, speculating on bond prices, and arbitrage between cash and futures markets.
* Contracts are standardized and marked to market daily; margin requirements and conversion factors govern delivery and pricing.
* Most traders close or roll positions before delivery to avoid physical settlement.

What are bond futures?
Bond futures are standardized futures contracts whose underlying asset is a government bond (for example, U.S. Treasury bills, notes, or bonds). When you buy or sell a bond futures contract, you agree to purchase or deliver the specified bond at an agreed price on the contract’s expiration date. Because these contracts trade on futures exchanges, they are highly liquid and regulated.

How bond futures work
* Standardized contracts: Exchanges define contract size, eligible delivery instruments, and expiration months (commonly quarterly: March, June, September, December).
* Daily settlement: Positions are marked to market each trading day; gains and losses are credited or debited to traders’ margin accounts.
* Closing versus delivery: Traders can close a position before expiration by taking the opposite trade, or they can hold to delivery. Most close or roll positions to later months to avoid taking or making delivery.

Who uses bond futures and why
* Hedgers: Bondholders, portfolio managers, and institutions use futures to lock in prices and manage interest-rate exposure.
* Speculators: Traders take directional views on bond prices or interest rates to seek profits.
* Arbitrageurs: Market participants exploit price differences between bonds and futures or across delivery-eligible bonds.

Delivery and the cheapest-to-deliver (CTD)
When a futures contract is settled by delivery, the short (seller) typically chooses which eligible bond to deliver. Exchanges allow a range of bonds within a maturity and coupon range; the short will often deliver the cheapest-to-deliver (CTD) security—the eligible bond that minimizes the seller’s cost of satisfying the contract.

Conversion factors
Exchanges publish conversion factors to standardize delivery across bonds with different coupons. A conversion factor adjusts the invoice price to account for coupon and accrued interest differences relative to a notional reference coupon (often 6% in examples). On delivery, the invoice price calculation typically is:
Invoice price = (futures settlement price × conversion factor) + accrued interest
The conversion factor makes bonds with different coupons comparable when settling futures contracts.

Margin and mark-to-market
* Initial margin: The amount required to open a futures position.
* Maintenance margin: The minimum equity that must be maintained. If the account falls below this level, the broker issues a margin call for additional funds.
* Purpose of margin: In futures, margin acts as a performance bond rather than financing the purchase. It ensures counterparties can meet obligations as the contract is marked to market.
* Daily P&L: Since positions are settled daily, profits and losses flow through accounts every trading day.

Risks
* Price risk: Bond prices move inversely to interest rates—rising rates typically lower bond prices and vice versa.
* Leverage and margin risk: Small moves in the futures price can produce large gains or losses relative to the margin posted.
* Delivery risk: If a position is held into delivery month, the short may deliver the CTD, which can produce outcomes different from the economic exposure the long expected.
* Counterparty and operational risk are reduced by exchange clearing, but market risk remains.

Where bond futures trade and how to buy them
* Major exchange: U.S. Treasury bond futures trade primarily on the Chicago Board of Trade (CBOT), part of the CME Group.
* Underlyings: Common contracts include short-term Treasury bills and 2-, 3-, 5-, 10-, and 30-year Treasury notes and bonds, as well as variants like Ultra bonds.
* Brokers: Many futures-capable brokers (for example, Interactive Brokers, TradeStation, and others) offer access to bond futures. Trading requires a futures-enabled account and sufficient margin.

Managing a bond futures position
* Monitor interest-rate expectations and macro drivers that affect bond yields.
* Use stop orders, position sizing, and risk limits to control downside exposure.
* Roll positions forward if you want continued exposure beyond the current contract’s expiration rather than taking delivery.
* Be aware of delivery month mechanics and deadlines; many brokers require earlier rollover to reduce operational risk.

Simple explanation
Bond futures let you lock in a price today for buying or selling a government bond at a future date. They’re like agreements that let investors protect against or bet on changes in interest rates—most participants close or roll their trades before the contract requires actual delivery of a bond.

Bottom line
Bond futures are powerful, liquid tools for managing interest-rate exposure, speculating on bond price movements, and performing arbitrage. They involve daily marking to market, conversion factors for delivery, and margin requirements that can amplify gains and losses. For most traders, active management and awareness of delivery mechanics are essential to avoid unintended outcomes.