Treasury trading strategies
Using bonds to invest for total return, or a combination of capital appreciation growth and income, requires a more active trading strategy and a view on the direction of the economy and interest rates. Total return investors want to buy a bond when its price is low and sell it when the price has risen, rather than holding the bond to maturity. Bond prices fall when interest rates are rising, usually as the economy accelerates.
They typically rise when interest rates fall, usually when the Federal Reserve is trying to stimulate economic growth after a recession. Within different sectors of the bond market, differences in supply and demand can create short-term trading opportunities. Various futures, options and derivatives can also be used to implement different market views or to hedge the risk in different bond investments.
Investors should take care to understand the cost and risks of these strategies before committing funds. Some bond funds have total return as their investment objective, offering investors the opportunity to benefit from bond market movements while leaving the day-to-day investment decisions to professional portfolio managers.
Many investors use callable securities within a total return strategy—with a focus on capital gains as well as income—as opposed to a buy and hold strategy focused on income and preservation of principal. Owners of callable securities are expressing the implicit view that yields will remain relatively stable, enabling the investor to capture the yield spread over noncallable securities of similar duration.
If an investor has the view that rates may well be volatile in either direction over the near term but are likely to remain in a definable range over the next year, an investment in callable securities can significantly enhance returns. Premium callables may be used when the bullish investor believes that rates are unlikely to fall very far. Discount callables are a better choice when the investor believes volatility will be low but prefers more protection in an environment of rising interest rates.
If you are in a high tax bracket, you may want to reduce your taxable interest income to keep more of what you earn. The interest on U. Municipal securities offer interest that is exempt from federal income tax, and, in some cases, state and local tax as well. Ladders, barbells and bullets can all be implemented with municipal securities for a tax-advantaged approach best achieved outside of a qualified, tax-deferred retirement or college savings account. Buying municipals in a tax-deferred account is like wearing a belt and suspenders. Bond swapping is another way to achieve a tax-related goal for investors who are holding a bond that has declined in value since purchase but have taxable capital gains from other investments.
He or she then purchases another bond with maturity, price and coupon similar to the one sold, thus reestablishing the position. Investors who want to achieve automatic diversification of their bond investments for less than it would cost to construct a portfolio of individual bonds can consider investing in bond mutual funds, unit investment trusts or exchange-traded funds.
These vehicles each have specific investment objectives and characteristics to match individual needs. To learn more, see Bonds and Bond Funds. A tax loss is not the only reason to swap a bond. Investors can also swap to improve credit quality, increase yield or improve call protection. Remember to factor the sell and buy transaction costs into your estimations of return.
For more information, see Bond Swapping.
Bonds, Notes, and Bills
Note that although the exchanges set the minimum margin requirements for futures, your broker may hold a higher margin requirement if it deems necessary. Margin requirements for bond options use a method called SPAN standard portfolio analysis of risk , which determines the potential loss of the position based on different scenarios in the bond futures price, time, and volatility. To apply for futures trading, your account must be enabled for margin, Tier 2 options Tier 3 for options on futures , and advanced features.
Take a look at the Getting Started section highlighted.
From there, you can a pply for any needed prerequisites or for futures trading. The strategies you use for bond futures and options can be based on probability and volatility, similar to equity options strategies. Bonds just offer a trader additional trading opportunities, particularly around economic events such as Fed meetings and employment reports.
Fixed Income Trading Strategy & Education
You may be long-term bullish or bearish on bonds if you expect interest rates to decrease or increase over time based on U. But, of course, past performance is not a guarantee of future results. Option traders often use defined-risk strategies such as verticals and iron condors to speculate on bonds going up, down, or sideways. Futures and futures options trading is speculative, and is not suitable for all investors. Please read the Risk Disclosure for Futures and Options. Trading privileges subject to review and approval.
Not all clients will qualify.
How to Analyze Bonds Like a Quant
Not investment advice, or a recommendation of any security, strategy, or account type. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading. Spreads and other multiple leg options strategies can entail substantial transaction costs, including multiple commissions, which may impact any potential return.
These are advanced options strategies and often involve greater risk, and more complex risk, than basic options trades. Investments in fixed income products are subject to liquidity or market risk, interest rate risk bonds ordinarily decline in price when interest rates rise and rise in price when interest rates fall , financial or credit risk, inflation or purchasing power risk and special tax liabilities.
Market volatility, volume, and system availability may delay account access and trade executions. Past performance of a security or strategy does not guarantee future results or success. Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses.
Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options. Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
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This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union. TD Ameritrade, Inc. All rights reserved. By Adam Hickerson February 27, 11 min read. Arbitrage is a stricter notion, referring to trading in identical assets or cash flows, while relative value is a looser notion, referring to using valuation methods value investing to take long-short positions in similar assets without necessarily assuming convergence, and is more associated with equities.
For example, in relative value investing one may believe that the stock of one mining company is undervalued relative to some valuation, while another stock is overvalued relative to this or another valuation , and thus one will expect the undervalued stock to outperform the overvalued stock, even if these are quite different companies.
The risk of a convergence trade is that the expected convergence does not happen, or that it takes too long, possibly diverging before converging. Price divergence is particularly dangerous because convergence trades are necessarily synthetic, leveraged trades, as they involve a short position. Thus if prices diverge so that the trade temporarily loses money, and the trader is accordingly required to post margin faces a margin call , the trader may run out of capital if they run out of cash and cannot borrow more and go bankrupt even though the trades may be expected to ultimately make money.
The Exciting World of Trading Treasury Bonds (Seriously)
In effect, convergence traders synthesize a put option on their ability to finance themselves. Prices may diverge during a financial crisis , often termed a " flight to quality "; these are precisely the times when it is hardest for leveraged investors to raise capital due to overall capital constraints , and thus they will lack capital precisely when they need it most. Further, if other market participants are aware of the positions, they can engineer such price divergences, driving the convergence trader into bankruptcy — compare short squeeze.
As with arbitrage, convergence trading has negative skew in return distributions it produces, resulting from the concave payoff characteristic of most such high-probability low-return strategies. Operators engaging in such trades will usually make consistent but relatively small profits, occasionally offset by significant losses, consuming previous profits earned over a long period of time.
The low probability of encountering a loss in such strategies can lead inexperienced traders to underestimate the severity of such a loss, and assume excessive levels of leverage, potentially leading to bankruptcy as in the LTCM case. From Wikipedia, the free encyclopedia. Retrieved 29 July