The Futures Bond Basis, Second Edition

Chapter4

THE FUNDAMENTALS OF BASIS TRADING

In this chapter we consider some further issues of basis trading and look at the impact of repo rates on an individual's trading approach.

4.1 RATES AND SPREAD HISTORY

4.1.1 Net basis history

One of the first considerations for basis traders is the recent (and not so recent) history of the basis. For instance, if the basis is historically high, a strategy might involve selling the basis, in anticipation that the levels will fall back to more ‘normal’ levels. The trader can sell the basis of the cheapest-to-deliver (CTD) bond or another bond in the delivery basket. Let us consider one approach here, tracking the basis of the CTD in an attempt to identify trade opportunities.

By tracking the net basis for the CTD, we are able to see the impact of the delivery option possessed by the short on the level of the basis. Figures 4.1–4.3 illustrate the behaviour of the net basis for the 6.25% 2010 gilt during the period September 2000 to September 2001. This bond was the CTD bond during this period.

Tracking the net basis allows us to observe the value placed by the market on the short future's delivery options. For purposes of illustration we also show the futures price, cash bond price and converted bond price in Figure 4.2 and the actual market repo rate in Figure 4.3 during the same period. The net basis is measured in price decimals, just like the futures and cash price.

Figure 4.1 Long gilt cheapest-to-deliver bond net basis history, front ...