Treasury Bond Futures Delivery, Conversion Factors, and P&L
Summary
The document explains how Treasury bond futures settlement relates to the economics of delivering a bond. The question contrasts closing a short futures position, where the contract multiplier translates a price move into mark-to-market profit or loss, with holding the position through delivery, where the invoice amount depends on the delivered bond’s conversion factor and accrued interest.
The answer resolves the apparent inconsistency by focusing on net basis, defined as the cheapest-to-deliver bond price minus the futures price multiplied by its conversion factor. During delivery, arbitrage keeps this basis near zero, linking changes in the bond’s price to conversion-factor-scaled changes in the futures price. Thus the conversion factor shapes the invoice-price movement associated with futures-price movement. This is a concise explanation; it does not detail delivery options, contract specifications, or how basis can vary outside the delivery period.
Key ideas
- Treasury futures delivery payment is based on the futures settlement price, the delivered bond’s conversion factor, and accrued interest.
- The cheapest-to-deliver bond links futures pricing to the delivery invoice.
- Near delivery, arbitrage tends to keep the net basis near zero.
- Changes in the cheapest-to-deliver bond price are therefore related to conversion-factor-scaled futures price changes.
- A fixed futures multiplier and a conversion-factor-based invoice describe different parts of the same delivery economics.
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Full text
# Trying to understand T-Bond futures settlement. What am I missing? # Trying to understand T-Bond futures settlement. What am I missing? Here's a puzzle I encountered when trying to understand how treasury bond futures (/ZB) are settled. Supposed I am short 1 September ZB contract at \$170, and on its last trading day the contract settles at \$165. If I were to close the contract at the last minute, my realized P&L will be \$1000 x (\$170 - \$165) = \$5000. That is, for every \$1 difference between my "entry" and "exit" price of /ZB, my final realized P&L is changed by \$1000. But what happens if I don't close the contract? If I understand it correctly, I will pick a bond to deliver, and be paid an "invoice price" which equals the Settlement Price (\$165) times a Conversion Factor, plus the Accrued Interest. For example if the cheapest to deliver (CTD) bond has a conversion factor of 0.9, then I'll be paid an invoice price of \$1000 x \$165 x 0.9 = $148,500 plus accrued interest. It seems obvious to me that the bond conversion factor (0.9) affects my realized P&L in this case. So how can it possibly be true that my P&L is not affected by bond conversion factor if I close the contract (because it is always a fixed 1000x multiplier), but is affected by bond conversion factor if I don't? ## Answer by dm63 (score 1) https://quant.stackexchange.com/a/28179 During the delivery month, the "net basis" defined as $$ CTD price - (conversion factor * futures price) $$ trades at around zero, otherwise there is an arbitrage. Therefore daily changes in the CTD price are equal to $ conversion factor * $ daily changes in the futures price. Hence it is appropriate that the invoice price change is also multiplied by the conversion factor.
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