This is How Professional Traders Trade Bonds - Interest Rate Futures Trading

Today, we're going to talk about bonds. What we're going to talk about in this video is more towards the back end of the yield curve. I'm here with my good friend, Donnie Schwartz. Donnie and I traded at a bond firm for eight years together. This is exactly how the entire firm would trade bonds. Right now, because my friend's here, we're going to talk about, Donnie, what would you say is your favorite trade on the yield curve?

Donnie:
My favorite trade on the yield curve is the NOB, the ZN/ZB trade.

Jonathan:
The ZN/ZB, exactly what we're looking at. Why do you like the NOB?

Donnie:
The NOB moves. It provides a lot of good trading opportunity.

Jonathan:
Right, so when you're looking at the yield curve, this is going to be the NOB right in front of us. But when we talk about the yield curve, let's talk about the yield curve like this. Say, you got a two year, and then you've got a five-year, you got a 10 year, you got a 30 year, and you have an Ultra. All this stuff over here, guys, these are all going to be Eurodollars. We're not talking about Eurodollars on this video, but two years is going to be the ZT, ZF, ZN, ZB and UB.

Now, the way to trade these things is, we don't really want to speculate or guess which way they're going. Not really a high probability trade, in my opinion. What we want to do instead of guessing on direction, we want to trade the relationship between the two. Maybe we want to do what we call a butterfly, the middle against the wings. But today, what I want to go over is the NOB and thirties against Ultra. We're going to be talking about the NOB here and 30 Ultra, and what this is going to be called is the BUB. These silly names are given straight from the Mercantile Exchange. So NOB, BUB, FOB, all those things are directly from the CME site.

Let's talk about this trade specifically. What we're looking at here is the ZN against the ZB, and this is going to be the ZB against the UB. Now, if I look at the yield curve, back to our yield curve example, and we talked about tens, thirties, UB. Again, we're trading the difference between them. The ZN/ZB is a difference of 18 years. The ZB/UB has a difference of 18 years as well, because what these contracts really are, the ZN, it's called the ten-year futures contract, but it's really a seven year. The ZB is a lot closer to an 18 year than a 30 year. That UB is going to be closer to the 30 year. We could trade these things together, because there's a very, very strong correlation between that 10 year and 30 year between the 30 year and Ultra.

What we do is we want to look for breakdowns in the market. That's really what we're doing as traders, waiting for those breakdowns to happen. What you can see here is July 24th, ZB/UB was very offered, very low, relative to the NOB. If we look at the NOB here, the NOB was considerably higher. So ZB/UB, look how much lower it is compared to the NOB relative to one another. As soon as that ZB/UB was obviously very inexpensive compared to the NOB, the NOB was already mid-range. If we go back to this chart and we look at 79 right here, you can see ZB/UB is way, way under its average range over that period. It was clear that the ZB/UB was inexpensive relative to the NOB.

This will get into, a few more advanced techniques, but what we're doing doing is, we're really doing a butterfly between the ZB against the ZN and against the UB. A little sloppy with all the charts, but I wanted to get this out to you. I got to tell you, it's a much more efficient approach than crossing your fingers and just guessing on rates going higher or rates going lower.