Treasury Futures Basis Trading
Treasury basis trading connects a cash Treasury security with a Treasury futures contract that can be settled by delivering one of several eligible bonds. The apparent arbitrage—buy cash, sell futures, finance in repo, and deliver—depends on the cheapest-to-deliver (CTD) bond, conversion factor, delivery timing options, and the availability of balance sheet. It is a relative-value trade with leverage and liquidity risk, not an unconditional yield pickup.
For a candidate deliverable, the quoted basis is commonly:
basis = cash clean price - futures price * conversion factor
This is an incomplete measure because accrued interest, repo carry, coupon income, and delivery invoice price matter. A more useful comparison is implied repo rate (IRR): the annualized financing rate embedded in buying the bond and delivering it against the future. Compare IRR with the actual incremental repo rate.
| Quantity | Meaning | Why traders care |
|---|---|---|
| Conversion factor | delivery price adjustment | standardizes coupon/maturity differences |
| Gross basis | cash minus adjusted futures | quick screen, not full economics |
| Net basis | basis after carry and fees | closer to P&L opportunity |
| Implied repo | financing embedded in trade | compares directly with repo |
| CTD | lowest-cost eligible deliverable | drives futures hedge ratio |
Cash-and-carry economics
If implied repo is materially above obtainable repo, a trader can buy the candidate bond, fund it, sell futures, and expect delivery economics to earn the difference. The reverse is constrained by the ability to borrow the bond and by delivery options. The calculations need settlement dates, accrued interest, coupon payments, and the contract’s delivery calendar—not just yield and duration.
def gross_basis(clean_price, futures_price, conversion_factor):
return clean_price - futures_price * conversion_factor
def delivery_invoice(futures_price, conversion_factor, accrued_interest):
return futures_price * conversion_factor + accrued_interest
def net_basis(clean_price, invoice, financing_cost, coupon_carry, fees=0):
return clean_price + financing_cost + fees - coupon_carry - invoice
Use exact day counts and cash-flow dates in production. A one-day settlement mismatch or missed coupon can dominate a thin basis. The simplified sign convention above also must be reconciled to the desk’s P&L system before an order is placed.
CTD and optionality
The short futures holder chooses which eligible bond to deliver and, in some contracts, the delivery date and invoice timing. The CTD can switch when yield-curve levels or shape move. Futures therefore embed delivery options; a static hedge using today’s CTD can develop duration and convexity exposure tomorrow. See bond futures and cheapest-to-deliver for the selection logic.
| Risk | Mechanism | Monitoring |
|---|---|---|
| CTD switch | relative bond prices change | rank net basis across all deliverables |
| Special repo | cash bond becomes scarce | monitor actual and stressed repo |
| DV01 mismatch | hedge ratio changes | calculate CTD-adjusted DV01 daily |
| Delivery option | futures price includes optionality | use option-adjusted valuation |
| Liquidity event | leveraged basis unwinds | stress haircuts and margin |
The common “basis trade” often uses repo leverage to turn a small spread into a meaningful return on equity. That makes funding access central. Higher repo haircuts, variation-margin calls on the futures short, or a sudden loss of term financing can force sales when the basis widens. Treasury liquidity can become segmented during stress, so a seemingly liquid cash security may not be liquid at the model price.
Modeling and testing
Construct a deliverable-bond table daily with clean/dirty price, accrued interest, conversion factor, coupon schedule, repo curve, and estimated delivery dates. Calculate net basis and IRR for every candidate rather than assuming the on-the-run bond is CTD. Revalue under parallel and curve shocks, repo specials, CTD switches, and wider bid-ask spreads. The best candidate is not always the one with the smallest gross basis.
Backtests must use historical contract deliverable lists and contemporaneous repo availability; generic SOFR funding is not an adequate substitute. Include transaction costs on cash bonds, futures roll, collateral, and delivery operations. Report unlevered spread, financing P&L, margin usage, and liquidation stress separately.
Key takeaways
- Treasury basis is a cash, futures, repo, and delivery-option relationship.
- Implied repo and net basis are more informative than gross basis alone.
- CTD can switch, changing hedge ratio and the value of the futures contract.
- Leverage, repo haircuts, and liquidity stress can overwhelm a small expected carry.