Trading Treasury Futures Bonds Spreads with an Edge

Trading Treasury Futures Bonds Spreads with an Edge

Bonds are in play!  How do we know they’re in play? How do we identify trades?  How do we determine if we should be long or short?  Which futures instruments should we trade – the 2 year (/ZT), the 5 year (/ZF), the 10 year (/ZN), the 30 year (/ZB) and/or the Ultra (/UB)?  Or Some combination (a spread)? How can we increase our chances of success by trading with an “edge”?

Let’s dive in and answer these questions!

How Do We Know Bonds are in Play?

There are times when there’s not much going on bonds.  There aren’t any catalysts and bond volatility is low – there isn’t a real reason to trade and take risk.  That isn’t the case now… bonds are definitely in play and it’s a good opportunity to look for trades and take on risk for the following reasons:

  • Interest rate hikes are coming as the economy accelerates
  • The Fed is beginning to pull back from their Quantitative Easing programs – they are starting to taper
  • Inflation is at the highest level in decades
  • The federal government is adding more and more stimulus
  • Bond volatility is on the rise. Look at the increase in the MOVE Index (the MOVE Index is like the VIX for Treasuries – it is the weighted average index of implied volatility across the treasury yield curve) over the last few months on Wall Street Wiretapper’s charting platform (Wiretapper is an AI-driven unusual options activity scanner offered by Masters in Trading):

  • TLT (the 20+ year Treasury Bond ETF) is all over Wall Street Wiretapper indicating actual volatility will outperform the implied volatility currently priced into the options:

Trading Bonds Spreads with an Edge

There are lots of ways to trade bonds… but let’s look at an approach that provides an edge, an opportunity to increase our chances of success, based on data and analysis.  Our focus is on RELATIVE VALUE:  a bond future or spread is not cheap or expensive on its own, it’s cheap or expensive RELATIVE to another treasury future or spread on the yield curve.  In other words, the /ZB future is not cheap or expensive on its own, it’s cheap or expensive relative to the /ZN or the /UB future.  When we’re doing our relative value analysis. we don’t have to analyze a single futures contract (a /ZB or /ZN for example), we can analyze a spread (a trade where we will be long one futures contract and short another – such as the “NOB” – notes over bonds – if we’re long the NOB, we’re long the /ZN and short the /ZB) for a different, possibly easier to manage risk profile.

Let’s look at two spreads using treasury futures for our relative value analysis, the NOB (/ZN vs. /ZB) and the BOB (/ZB vs /UB) and see if there’s a setup.  Here’s the way the spreads look on the new Masters in Trading Futures EDGE Charting Platform:

This is a two hour chart for the last 90 days.  Notice anything?  The NOB and the BOB trade together for a while and then there’s volatility and separation.  Look how the NOB (the /ZN vs the ZB) has recently traded lower and the BOB (/ZB vs the /UB) has recently traded higher.  In this case, we would say that the NOB is inexpensive (cheap) relative to the BOB.  Based on this analysis, we would buy the NOB, which is relatively cheap, and sell the BOB which is relatively expensive.

As added confirmation, let’s look at the NOL, which is the /ZN vs the /UB or a combination of the NOB and the BOB (NOB + BOB):

Notice how the NOB and the NOL are moved lower together, and the BOB seems out of synch.  This is confirmation to sell the BOB since it is expensive and buy the NOB.

Understand the Trade Before Risking Money

At Masters in Trading, we’re always looking for relative value trades.  In this example, we reviewed a relative value trade in bond spreads.  Trading bond spreads is a more advanced topic.  Make sure you fully understand the trade before risking real money….paper trade, paper trade, paper trade!  We have lots of resources at Masters in Trading to help you on your “trading bond spreads” journey!


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