There is a massive spread between the March T-Bond futures contract and the June contract. What caused this?
As traders shifted focus from the March 30-year bond futures contract, into the June contract, calls and emails began flooding in. In general, futures traders are aware of, and accept, a certain amount of contango or backwardation representing the difference between the current contract month and those contracts with more distant expirations. However, the massive spread between the June and March 30-year bond futures is breathtaking…it left many wondering if it was a rare market inefficiency, or even the trade of a lifetime, but it isn’t…there is a good explanation.
As a refresher, all futures contracts have an expiration date; when the current contract month is trading at a lower price than contracts expiring at a later date, it is referred to as contango. Contango exists in a normal commodity market because of the cost to carry and insure the underlying asset is priced into future contract months. Backwardation, on the other hand, is an environment in which the current contract month trades at a higher price than those expiring on a later date. Typically, these terms aren’t used to describe the relationship between the various expiration months of financial futures, but the concept is the same. Rarely will subsequent expiring futures contracts trade at the same price as the current front month.
At the time of this writing, the spread between the March and June 30-year bond futures was approximately 18 full handles; specifically the March contract was valued near 149 and the June was trading near 167. For those familiar with Treasury futures pricing, an 18 handle spread is equivalent to $18,000 per contract. In more normal circumstances, the difference is usually between 1 and 3 handles. Further, the typically minimal price variance accounts for expectations interest rate changes between the March expiration and the June expiration. However, in the current anomaly, the approximate spread of 18 points is the result of a difference in the basket of deliverable securities; thus, it has little to do with a change in yield (or expectations of differences) between the March and June contract expiration. In fact, the presumed yield in the June contract is nearly identical to that of March.