Sovereign Yield Spread Futures
Frequently Asked Questions
March, 2012
OVERVIEW
金属钙1.What are Sovereign Yield Spread futures?
Sovereign Yield Spread (Sovys) futures are a new product that wraps a sovereign yield spread exposure into a single futures contract. Sovys futures enable a market participant to shed or acquire exposure in a conventional sovereign bond spread in one trade, rather than as a spread requiring active management of distinct long and short component positions.
Sovys futures will begin trading on Monday, May 23, 2011 and will be listed exclusively on the CME Globex electronic trading platform.
2.How do they improve upon the alternatives?
Before the introduction of Sovys futures, the alternatives to executing a sovereign yield spread were limited to combinations of cash government bonds and/or futures.
With Sovys futures, spread exposure is reduced to one transaction. There is no need to execute and manage the spread’s individual legs across multiple cash bond markets or multiple futures exchanges. Moreover, margin is posted with one central counterparty—CME Clearing—rather than with multiple clearing houses.
3.Who benefits?
For a wide variety of market participants, Sovys futures make trading and monitoring of sovereign yield spread exposures simpler, more cost-effective, and more efficient than ever.
Asset Managers:Sovys provide an operationally simple and capital-efficient means to add a “core plus” component to fixed income portfolios. For the diversified global bond fund manager, they make
a cost-effective tool for risk management and allocation adjustments.
Hedge Funds: Sovys offer unique arbitrage opportunities by enabling access to leverage in non-dollar fixed income markets.
Proprietary Traders:Sovys permit efficient and cost-effective trading in non-dollar bond spreads.
Banks/Government Bond Traders:Sovys make effective risk-management tools to hedge sovereign spread exposures within the bank treasury portfolio, to facilitate participation in government securities auctions, and to enable provision of cash market liquidity to customers.
CONTRACT DESIGN
4.What is the contract underlying reference?
Sovys futures reference pair-wise spreads among the following classes of government bonds:
France (OATs)
Germany (Bunds)
Italy (BTPs)
Netherlands (DSLs)
UK (Treasury Gilts)
US (Treasury Notes)
At initial launch, the Sovys futures suite will comprise 12 spread combinations:
US – UK
US – Germany UK – Germany
US – France UK – France Germany – France
US – Italy UK – Italy Germany – Italy
US –Netherlands UK – Netherlands Germany – Netherlands
The first nation in each combination is defined as the “Bought” Nation in the contract’s notional spread, and the second nation is defined as the “Sold” Nation.
For any given Sovys contract, Reference Bonds for both of the governments comprised in the contract’s reference yield spread must have remaining term to maturity between 8 years 1 month and 10 years from the contract Delivery Month.
Example: Reference Bonds for Sovys futures for a hypothetical March 2011 delivery would be
required to mature between 1 April 2019 and 31 March 2021, inclusive.
5.What is the contract size?
0.01 price points = 1 bp = 100 Currency Units.
In terms of the minimum price increment, 0.0025 price points = ¼ bp = 25 Currency Units.
6.The Reference Bonds represent three different currency denominations. How does the
Sovys contract mechanism account for this?
The terms and conditions for each Sovys futures contract designate a contract Currency Unit. The following table summarizes Bought and Sold nation pairs and their respective Currency Units.
Bought and Sold Nation Pairs and Currency Units
Sold Nation: UK Germany France Italy Netherlands
Bought Nation:
US £ € € € €
UK £ £ £ £
Germany € € €
Thus, for instance, the US-German Sovys contract is sized at 0.01 points = 1 bp = €100, whereas the UK-German Sovys contract is sized at 0.01 points = 1 bp = £100.
7.How are Sovys quoted?
Sovys futures are quoted on the basis of a modified IMM Index:
100 + Yield Spread
where Yield Spread is the difference between Sold Nation yield minus Bought Nation yield that’s expected to prevail at contract expiration. Prices are quoted in minimum increments of 0.0025 price points, i.e., one-quarter of one basis point of contract reference yield exposure.
Example: US-UK Sovys futures define US as Bought Nation and UK as Sold Nation. Suppose the
prevailing view among market participants is that the UK yield will exceed the US yield by 0.135
percent (i.e., 13.5 basis points) per annum at contract expiration. The contract price could be
expected to trade in the realm of:
100 plus UK yield minus US yield = 100 + 0.1350 = 100.1350
Suppose the yield spread then widens, such that the UK yield is expected to be 25.75 basis points above the US yield. The contract price would rise to:
100 plus UK yield minus US yield = 100 + 0.2575 = 100.2575
8.What is the schedule of delivery months?
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Sovys futures will trade for expiry in March quarterly months, i.e., March, June, September and December. Four delivery months will be available to trade at a time.
9.Which delivery months will be listed at launch?
At initial launch, the September 2011, December 2011, March 2012 and June 2012 expiries will be listed.
10.What are the trading hours for Sovys futures?
Sovys trade 5:00 pm to 4:00 pm Chicago time, Monday through Friday, exclusively on CME Globex.
11.Are Sovys futures eligible for block trading?
Yes. The minimum block trade threshold for Sovys is 250 contracts. To learn more about block trade rules, reporting, and submission, click here.
TRADING SOVYS FUTURES
12.How do Sovys futures improve the cost efficiencies of executing spreads between fixed
income instruments?
In addition to margin efficiencies and the execution risk of legging a trade, there are at least four additional costs that one needs to consider when executing a spread trade between two different foreign bonds. Consider the alternative of a Sovys futures contract of Bought UK- Sold Germany versus the costs of executing the spread on two different exchanges:
Transaction Costs—one has to pay a transaction fee on both the UK leg and on the Germany leg, instead of one fee on the Sovys spread.
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Bid/Ask Spread—one has to purchase UK at the “ask” side and sell Germany at the “bid” side
instead of simply buying the Sovys spread at the “ask” side of the market.
Currency Denomination Adjustment—one must transact currency trade(s) of sterling/euro to
convert the initial-variation margin of the Germany leg, instead of simply executing a Sovys spread where margin is already denominated in sterling.
Rebalancing Costs—as yield levels change on either bond leg, one may need to incur all three of the costs above to rebalance to remain duration and currency neutral to the spread only.
惊天霹雳13.In what currency will Sovys futures margins be posted?
For any given Sovys contract, margin pays and collects are denominated in the contract Currency Unit. All UK Sovys spreads have margin pays and collects denominated in UK pounds; all other SOVYS spreads are denominated in Euros. For example, margin payments for US-German Sovys futures will be in Euros, whereas those for US-UK Sovys futures will be in UK pounds. Again, the structure of the Sovys futures contract requires that margin only be posted with CME Clearing.
14.In spread terms, what am I buying or selling?
If I buy Sovys futures, then I buy the yield spread: I am a notional buyer of Bought Nation bonds and a notional seller of Sold Nation bonds. If I sell Sovys futures, then I sell the yield spread: I am a notional seller of Bought Nation bonds and a notional buyer of Sold Nation bonds.
When one buys a Sovys one expects that:
a.Price of the Sovys contract will go up.
b.Yield spread between the Sold Nation and the Bought Nation will widen.
c.Yield on Bought Nation bonds will go down and/or the yield on Sold Nation bonds will go up.
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d.Price of Sold Nation bonds will go down and/or the price of Bought Nation bonds will go up.
If one sells a Sovys, the opposite applies. One expects that:
a.Price of the Sovys contract will go down.
b.Yield spread between the Sold Nation and the Bought Nation will narrow.
c.Yield on Bought Nation bonds will go up and/or the yield on Sold Nation bonds will go down.
d.Price of Sold Nation bonds will go up and/or the price of Bought Nation bonds will go down.
15.Does it make any difference if the contract yield spread is negative rather than positive? Not at all.
The Sovys futures contract is always standardized in terms of its designated Bought Nation and Sold Nation, irrespective of whether the contract reference yield spread (Sold Nation yield minus Bought Nation yield) is positive or negative.
16.What if I want to spread nations other than the 12 designated Bought and Sold Nation
pairs?
At the present time, the previously indicated bought and sold nation currency pairs are the only ones offered for direct trading. However, the flexibility of Sovys futures allows one to synthetically create other spread opportunities by executing two spread pairs.
Example:To create a Sovys spread pair consisting of a “Bought” Netherlands and a “Sold” Italy,
one could execute:
Bought US-Sold Italy plus Sold US- Bought Netherlands = a synthetic Bought Netherlands-Sold
Italy
17.How can I see prices for Sovys futures?
Sovys futures are traded on a regulated market, with a transparently determined daily mark-to-market. Prices for Sovys will be readily available on the CME Group website, as well through a number of quote vendors. Quote vendor symbols will be posted on the website prior to launch. 18.How can I get access to CME Globex?
To access CME Globex you must have a relationship with a CME Clearing Member Firm. For more information on getting connected to CME Globex, please click here.
CONTRACT EXPIRATION
19.When exactly does a contract expire?
Last Trading Day for an expiring Sovys future is the 3rd London-NY-TARGET business day before
10th day of the Delivery Month. Trading terminates at 3:02 pm London time on last trading day.
20.What happens at contract expiration?
Each Sovys contract is cash-settled by mark-to-market to a Final Settlement Price determined on the contract last trading day.
21.How is the final settlement price determined?
The Exchange obtains bond prices from Interactive Data, the designated third-party valuation service. On the Sovys futures contract’s last trading day, Interactive Data furnishes to the Exchange a valuation for each Reference Bond, for standard settlement (T+1 for US and UK, T+3 for all EU), based on government securities market activity between 3:00 and 3:02 pm London time.
For each Reference Bond, the Exchange converts price to yield. For each sovereignty, the Exchange then computes the median of Reference Bond yields. For instance, the representative yield for UK is the median of yields to maturity on all gilts that are admissible as Reference Bonds, while the representative yield for Germany is the median of yields on all Bunds that are eligible to stand as Reference Bonds.
The Exchange uses these median yield values to calculate each Sovys contract’s Final Settlement Price:
Final Settlement Price = 100
plus the median of Sold Nation Reference Bond yields
minus the median of Bought Nation Reference Bond yields
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