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Enhancing Treasury Futures Basis Returns with an OIS Hedge

Article Quant Q&A · Author: VanillaCall
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Summary

The document examines whether a Treasury futures basis trade can earn more than the implied repo minus the bond’s actual repo financing cost. It proposes adding an overnight indexed swap hedge, with the answer correcting the hedge direction: pay fixed and receive overnight OIS through the futures delivery date. The resulting profit and loss combines implied repo minus the fixed OIS rate with the difference between daily OIS and daily repo rates.

The discussion frames the swap component as a fixed spread plus a floating financing spread that the trader hopes remains favorable over the trade’s life. It does not provide market data, a worked trade, or evidence that this enhancement is reliably profitable. The analysis assumes away cheapest-to-deliver switches and leaves practical concerns such as changing repo conditions, hedge implementation, and other basis risks unresolved.

Key ideas

  • A Treasury basis position can pair a short futures contract with a long underlying bond.
  • The proposed OIS hedge pays fixed and receives overnight OIS through delivery.
  • The combined return depends on implied repo relative to the fixed OIS rate and on daily OIS relative to repo.
  • A favorable floating spread is an expectation, not a guaranteed outcome.
  • The discussion assumes no cheapest-to-deliver switch and does not assess other practical risks.

Tags

FuturesFixed incomeCarryDerivatives pricing
Full text
# Treasury Futures Basis Trade - Funding enhancement


# Treasury Futures Basis Trade - Funding enhancement












In a basis trade, if you short the Treasury futures and buy the underlying bond and hold it to maturity, is funding the only source of risk assuming there no CTD switches. You have locked in the financing rate (repo) on the bond and the futures leg doesn't require financing. Your return would be implied repo - actual repo.

Is there a way to enhance the return you earn and is this practical? For example, can you lock in the repo and receive OIS swap rate, then paying rolling overnight Fed funds rate. The cash flow you're left with is

implied repo - actual repo + (OIS - rolling overnight Fed Funds)

If rolling overnight Fed Funds = OIS rate that you locked in, then your return is just implied repo - actual repo + 0

However, if rolling overnight Fed funds < OIS rate, then your return would be higher: implied repo - actual repo + (OIS > rolling overnight Fed Funds).

## Answer by dm63 (score 1)

https://quant.stackexchange.com/a/46369

I think you have the hedge wrong way around. You want to pay fixed /rec ois to the delivery date. Then your p/l will be (implied repo -fixed rate on ois swap) + (daily ois rate -daily repo rate).

The idea is that the first term is a fixed positive number (say 20bp) and the second term you hope stays around -5bp through the life of the trade.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.