NuclearPhynance Archive

If you are trading the cash bonds (btec, espeed) against the treasury futures, how do you determine a ratio so that the basis does not move intraday?  For naive pairs (10 futures vs 1 cash), it appears that the basis moves significantly intraday.

No matter what ratio you use, the basis will always move, that's why there are basis traders Smiley



Depending on what you want to capture, exactly, you use different hedge ratios. The most common hedge ratio is DV01 (adjusted for optionality).

I agree with FDAX. The fact that the bugger moves is the whole point of trading basis.

> Depending on what you want to capture, exactly, you use different hedge ratios.



If I want to make a market, then I'm looking for a spread that may move a bit in the short (minutes, hours, even a day or two) but regularly comes back to a constant value.  Any suggestions how to construct such a thing?



I'm very new to cash bonds, let me know if what I'm after is impossible.

sounds you want very high reversion pairs. index future rolls/ basis trades, ir curve spreads, corr swaps etc are all about trying to get the reversion. ofcourse a spread that had a mean value of 0 and moved between +10 and -10 (never breaching the limit) would find massive buyers or sellers as highs and lows (very high prob of making money/ good risk return etc) would approach therefore the move to the extremes will become damped till the time all vol will die down and you wont be able to capture any moves.

> sounds you want very high reversion pairs



Exactly, that is a better way of asking for it than my initial question.  Your explanation of why volatility in perfectly reverting pairs makes sense. 



However, I've been unable to find any non-volatile pairs.  Can you suggest any combinations of cash bonds and bond futures that are non-volatile?

HockeyPlayer:Can you suggest any combinations of cash bonds and bond futures that are non-volatile?



Yes, the cash bond and the bond future where the deliverable basked only consists of that cash bond....



Seriously, you need to realize that the bond future basis is one of the most competitive basis trades in the world. There's guys that have been doing this for two decades. They aren't exactly waiting for you to come in there "oh... I'll just buy 14s and sell 16s. And then... I'll sell 16s and buy 14s". There's a lot of competition in that market and if you don't understand what makes up the basis and can price all the optionality correctly and judge various other effects, you're probably better off not touching it. What, you think you're the first guy to figure out that the basis somewhat mean reverts?



Now, if you really want a low-volatility bond basis.... try 13 week T-Bill futures on the CME.... Smiley

There is a paper on HFT pair trading in Treasuries.  Google it.

I realize the basis trade is competitive.  While I'm new to bonds, I'm not new to reverting pairs.  We have significant experience trading such pairs, as well as a low latency platform for execution. 



What I don't know is how to construct a stable pair out of cash bonds and futures.  Are you telling me that constructing the pairs is difficult, or that being able to get an edge in the pairs will be difficult?  If I can figure out a stable pair, we'll be able to see if our system is fast enough to get the edge.



@jungle, thanks for the paper tip; I found Nath's paper from 2003.  While interesting, it talks about trading once a day, while I'm looking to trade 100+ times/day.

But you understand the optionality in the futures contract right? You understand where extra gamma comes from or is that what you are trying to understand?