Understanding U.S. Treasury Bill Futures Spreads

SOFR futures are well-suited for mitigating risk within cash T-bill portfolios, as they share a similar characteristic of risk reduction with the passage of time. Each day that elapses provides additional clarity on where the SOFR futures hedge will eventually settle, thanks to the release of more known fixings. Simultaneously, the remaining duration of cash T-bills steadily diminishes, aligning the risk periods of both cash and futures positions. 

Those who hedge cash T-bills with SOFR futures should be mindful of an inherent asset swap risk within their positions. Notably, T-bill yields respond to external market conditions, such as economic data or changes in T-bill supply, differently in terms of both speed and magnitude when compared to SOFR rates. 

To mitigate the asset swap risk present in their position, a SR3/TBF3 spread can be deployed to hedge the portfolio. 

Consider a scenario in which a portfolio holds a long position in cash T-bills and a short position in SOFR futures, thus exposed to asset swap risk. Such a portfolio may opt for a short U.S. T-Bill futures vs. long SOFR futures spread trade to counteract this risk. This trade operates as an overlay to the underlying portfolio, effectively offsetting the short SOFR futures risk in the original portfolio while introducing a short U.S. T-Bill futures risk. 

It’s important to note that U.S. T-Bill futures rely on a forward-looking single point-in-time rate determined at auction, with the contract expiring upon the publication of auction results. Consequently, customers employing U.S. T-Bill futures to hedge cash T-bills must roll over their hedge at each expiration to maintain sensitivity to expected T-bill yields. Those using U.S. T-Bill futures vs. SOFR futures to neutralize asset swap risk similarly need to roll the intercommodity spread trade forward at each expiry. 

Consider the following hypothetical portfolio: 

Long $100,000 DV01 Treasury bills with time to maturity between one month and six months.

Short $100,000 DV01 SOFR futures across SR1 and SR3 in multiple expiries to most accurately offset the interest rate risk of the Treasury bills in the portfolio. 

Should an unforeseen surge in the supply of bills or a shortage of demand occur, a portfolio of this nature could face potential losses. To mitigate this risk effectively, a trader may choose to hedge their position by implementing a spread strategy involving a SR3/TBF3 spread. 

Each futures contract is characterized by its association with the IMM index. In this particular scenario, both SR3 and TBF3 contracts are standardized at $25 per contract per basis point. To effectively hedge the initial $100,000 portfolio risk, the recommended overlay would encompass a strategic spread position of 4,000 contracts. 

Long 4000 December SR3 futures @ 94.55 (yield = 5.45) 

Short 4000 December TBF3 futures @ 94.64 (yield = 5.36) 

Consider the scenario where U.S. T-bill yields experience an average increase of 5 basis points, due to heightened supply. Consequently, this uptick in yields leads to a decline in the prices of U.S. T-Bill futures. Simultaneously, the SOFR yield curve also undergoes an upward shift, with an average increase of 2 basis points. 

Our portfolio is now as follows: 

Long $100,000 DV01 Treasury bills down by average of 5bp 
Short $100,000 DV01 SOFR futures down by average of 2bp 
This original part of the portfolio has lost $300,000

And: 

Long 4,000 December SR3 futures @ 94.53 (yield = 5.47)

Short 4,000 December TBF3 futures @ 94.59 (yield = 5.41) 

The price of the futures spread transitions from -9 basis points to -6 basis points, indicating a 3 basis point increase. With a quantity of 4,000 contracts in play, this shift translates into a profit of $300,000 (3 basis points x 4,000 contracts x $25 per contract), effectively offsetting the loss incurred in the initial portfolio. 

Exhibit one depicts SR3/TBF3 spreads implied by actual SR3 final settlement prices and hypothetical TBF3 final settlement prices between December 2018 and May 2023, inclusive.