Spread Betting on Bonds & Long Term Interest Rates
In addition to taxing and collecting money from citizens like you and me, governments also borrow funds in the international credit markets. This is done by auctioning and issuing bonds to interested parties; these consist of interest-bearing instruments that can then be bought and sold in the market.
Most of the spread betting firms will make a market in the principal international bond categories including UK Gilts (i.e.UK government bonds), the US Treasury Bond and 10 year Treasury Notes, and German Bunds. These are divided up into short-term (two year) bonds referred to as Euro Schatz, medium term (five year) bonds called Euro Bobl, and long term (9 years +) bonds referred to as Euro Bunds. UK bonds are usually referred to as ‘gilts’, while US bonds are referred to as ‘Treasuries’ or ‘Treasury notes’.
Spread Betting on Bonds and Long Term Interest Rates
Eurodollar Spread Betting
Short Sterling Spread Betting
Euribor Spread Betting
German Bund Spread Betting
US T-Bond Spread Betting
US 10 Year Note Spread Betting
How to Spread Bet UK Long Gilts
Spread Betting on BTP Italian Bond
Euroswiss Interest Rate Futures
German Euro Buxl Spread Trading
German Euro Schatz Spread Betting
The popular (benchmark) bond issues consist of the 10 years bonds; meaning that such bonds are issued with a 10-year expiration. Here, the government is essentially promising to pay back the bond holders the full amount borrowed in 10 years’ time. At the same time, the government will pay the interest rate coupon attached to the bond when it is first issued throughout the life of the bond. Governments bonds have different maturities since they have different financing requirements; i.e. they need access to both short term as well as long term borrowings in order to balance their books.
When spread betting bond markets, it is important to note that you do not own the underlying bond. No government is actually borrowing from you, and no government will pay you back in 10 years’ time. What you are doing in practice is to trade the futures markets via the spread betting company based on government bond prices. Bond futures traders and spread betters aim to make a gain from the change in price, as opposed to the interest that that governments pay on the bonds.
Trading government bond markets via financial spread betting means that you are speculating on the financial health of the government issuing those bonds. Factors influencing this will be Economic forecasts, reports and statistics by government agencies (unemployment or inflation numbers for instance), any indicator about how well the country’s economy is doing can affect the price of its bonds.
Long Term Interest rates are reflected in the price of government bonds. Government Bond Futures allow you to trade on the long term rise or fall of interest rates from around the globe. Taking the case of the 10-year gilt futures contract, which expires on 1 September an investor could for instance stake £10 per every point or move of 0.01 that the price rises from the bid-offer spread of 103.47/103.51, buying at 103.51. If the price rose to 104.51/104.55, then he would have made £1000 [10451 - 10351 * 10].
SPREAD BET BOND CONTRACTS
- Gilts – UK Government bonds
- Treasury Bonds – US 30 Year bond (very big market) – one point means 1/32
- Treasury Bond Decimalised – same as above but decimalised – one point means 0.01
- Treasury Notes – US 10 & 5 Year bonds – one point means 1/32
- Treasury Notes Decimalised – same as above but decimalised – one point means 0.01
- Bund – European (Euro currency) 10 Year bonds
- Euro Bobl (Eurobobl)
- Euro Schatz (Euroschatz)
- JGB – Japanese 10 Year Government bond
With some spread betting providers you can even speculate on the movements of exchange traded funds (ETFs), such as the iShares £ Corporate Bond (SLXX) for the UK, as well as the iBoxx $ Investment Grade Bond and Ishares $ Corp Ishares USD Corporate Bond for the US.
Notes regarding the Bond Futures Contracts
- Treasury Bonds and Treasury Notes basis the official closing price on the provider’s last trading day of the relevant futures contract as reported by CBOT.
- Long Gilts basis the official closing price of the LIFFE Long Gilt futures contract on the provider’s last dealing day.
- German Bund, Bobl and Schatz at the Final Settlement Price of the relevant futures contract as determined by Eurex at 12.30 CET on the last trading day.
- Japanese 10-year Government Bonds at the final settlement price of the 10-year JGB futures as reported by TSE on the last trading day.
Spread Betting Bond Markets
- The leverage that spread betting allows is particularly important when trading bonds as bond prices only change incrementally over days or weeks.
- Two elements make up the value of a bond – the price and the yield. Remember a bond is a piece of sovereign or corporate debt. Bonds are usually issued at a par value of £100 and will pay an interest known as the coupon. The coupon will depend on the prevailing interest rates at the time the bond is issued, so if the coupon is 7% then each £100 bond will pay £107 at the end of the year.
- When trading bond markets using spread betting, one thing to follow is the bond yield. A bond’s yield is a good measure of how much of the current value of the bond is represented by the amount paid out in interest. In general, the lower the bond price goes, the higher the yield becomes. If a bond pays out 6% a year on £100, its yield will be 6%. If its price then falls to £90, that 6% rate now accounts for a yield of 6.667% (100/90 x 6). So when market analysts speak about yield going up, this in practice means that bond prices are going down.
- Bonds can be bought or sold in the bond market. The primary market is where borrowers issue bonds. The secondary market is where ‘second hand’ bonds are traded after they have been issued. After the bond has been issued, the price of the bond will change to reflect the prevailing level of interest at the time.
- Remember that if interest rates rise, then bond prices will go down and vice-versa; if interest rates went down the bond would continue to pay £7 per year so its price would increase to above £100 so that the yearly yield would follow the lower interest rates. Bonds prices are, therefore, inversely proportional to bond yields. As the price rises the yield falls. So if the expectation is that interest rates are likely to fall, a trader would go long (buy the bond), and sell if interest rates are likely to rise. Other influential factors affecting the prices of bonds can include the chance of the issuer defaulting on the repayment of the bond and inflation figures.
- The bonds markets also provide good opportunities for spread bettors looking to bet on future inflation levels. Insofar as inflation (or deflation for that matter) is very much correlated with the oil price, it is a high dollar value per barrel that holds inflation expectations, and with this interest rate expectations which are in positive territory at the moment.
- Note that spread betting your profits will always be in pounds even if you are dealing in overseas bonds. This means that when spread betting bond markets you don’t have to worry about currency risks – you simply have to focus on the change in the bond price. This would not be the case if you were to buy a foreign bond security, like a US government bond, since as a UK investor you would also be taking on the risk of any weakening of the pound against the dollar.
- Betting on bond prices is a good way to bet on forthcoming interest rate decisions; in fact watching the price movement of bonds will give you an idea of how the market anticipates future interest rate moves. If it seems like a government is likely to start raising interest rates, those bonds it has already issued with lower rates will get cheaper as investors will be less willing to buy them (will wait for the higher bearing interest bonds). This also works in reverse – if a government is looking into cutting interest rates, meaning that it is planning to pay less money for what it borrows in the market, those higher paying bonds it issued 6 years ago will look more attractive in the eyes of investors, and their price will go up.
Spread Betting the US T-Bond Market
The big market on interest rates is the US T Bond market (a bellwether of credit market sentiment) which is traded 24 hours a day and is easy to trade but can be off putting as the price is quoted in fractions (1/32nds) rather than decimals.
To quote an example: March treasury bonds are trading at 127-23 which is 127 and 23/32nds. You believe rates will rise and bond prices to fall. The bid-offer spread is 127-20 to 127-26 and you sell $15 at 127-20. That’s $15 per 1/32nd.
The market moves against you and rates fall instead of rising. Bond prices rise and the bid-offer spread now moves up to 128-2/128-8. You buy at 128-8 to close the position. The loss would amount to:
Opened at 127-20
Closed at 128-8
Difference = 20 (i.e. 20/32nds) x $15 unit stake = $300 Loss
Let’s take another example, the US T Bond is currently trading at 98-20 and we get a quote of 98-17 to 98-23 and we decide to go long at 98-23 at $10 per point. Interest rates fall and T Bonds consequently rise in value so you decide to sell at 101-11
Opened at 101-11
Closed at 98-23
Difference = 84 32nds x $10 unit stake = $840 Gain
Some spread betting providers will allow you to use a decimalised contract to bet on the T-Bond. This option allows you to trade the T-Bond with prices quoted in decimals rather than the traditional fractions.
Buying a foreign bond in the traditional way exposes traders to currency exchange rates between their home currency and the foreign currency concerned for the full value of their exposure – a spread bet on a foreign bond however will involve no currency exchange risk at all (if the bet is denominated in the home currency).
Traditionally, spread betters who play the bond markets tend to be experts in interest rate movements, and they usually stake more money per bet than any other spread better. A spokesman for Capital Spreads said that the average stake per point in the movement of gilt futures is £40, compared to an average stake of just £7 across all markets.