‘Humongous’ Treasury Future Surge Suggests Math Error

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It looks like a Treasury futures trader failed to do his or her homework.

The price of 30-year Treasury futures expiring in June traded for less than 145 for about two hours yesterday before shooting up to more than 150. The 7.3 percent surge in their price yesterday, on the first day these particular contracts were traded, was unprecedented for 30-year Treasury futures, according to data compiled by Bloomberg. Volume amounted to 1,639 contracts with a notional value of $164 million.

What sets these futures apart from others is they’re the first ones where the U.S. government’s decision to stop issuing 30-year bonds from 2001 to 2006 must be accounted for when valuing the derivatives. The size and speed of yesterday’s jump indicates the initial traders of the contracts hadn’t factored in the unusual rules governing these particular products, said Craig Pirrong, a finance professor at the University of Houston.

“That is humongous,” said Pirrong, referring to the 7.3 percent jump. “We’re talking about a move you might see over weeks or a month occur in a day.” Pirrong said he suspected it was an algorithmic trader using an outdated model. “I would not want to be that guy,” the professor said.

CME Group Inc., which runs the exchange were they trade, had decided that the June 2015 contracts would be the first where the lack of underlying 30-year Treasuries should be reflected in valuing the futures. That ruling, which also applies to September 2015 and December 2015 contracts, was posted on CME Group’s website last year and again as recently as Sept. 17.

Price Mismatch

The first trade in the June contract occurred yesterday at 11:17 a.m. New York time at a price of 141 12/32, according to data compiled by Bloomberg. That was close to the March contract price of 140 29/32, which is valued differently due to the Treasury bonds that can be delivered under its specifications.

The trader most likely thought he or she could sell the June contract at the higher price and buy it back cheaper when it came in line with the March future, Pirrong said. However, the June contract had an implied value of around 151, based on the maturity and coupon of the Treasury bonds that can be delivered, according to calculations by one trader, who spoke on the condition of remaining anonymous.

‘Some Responsibility’

The June contract surged to 151 15/32 by the end of the day, compared with 140 29/32 for the March future, data compiled by Bloomberg show. Today, the June future fell 0.9 percent to 150 3/32 as of 4:32 p.m. New York time, and the March contract dropped 0.5 percent to 140 7/32.

CME “has some responsibility here because if they are changing the delivery basket, and if they are recognizing that the contract is artificially priced, they should allow some mechanism to adjust that price,” said David Robin, managing director and interest-rate strategist in New York at Newedge USA LLC. Such an alert should be “fair, efficient and fully transparent to the marketplace,” he said.

Alex Gorbokon, a CME spokeswoman, declined to comment on CME’s role in the trading.

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