Why Treasury Auction Stop-Throughs Can Hurt Dealer Shorts

Summary

The document examines dealer profits from shorting when issued Treasury securities ahead of an auction and covering the position at the auction clearing yield. It asks why a stop through, where the auction yield is below the when issued yield, could mean a loss if the dealer had shorted earlier in the day at a lower yield. Since bond prices move inversely to yields, the outcome depends on the dealer’s entry point as well as the auction result.

The response agrees that the example would produce a gain under the stated early entry, but says this timing is atypical. Dealers more commonly establish the short near the auction deadline, when the when issued yield may be near the auction’s final level. If the auction stops through that entry yield, buying bonds at the auction means covering at a higher price and losing on the short. The discussion is brief and illustrative; it does not provide broader data on dealer positions or auction outcomes.

Key ideas

• A Treasury stop through occurs when the auction clearing yield is below the when issued yield.
• The profit or loss on a dealer’s short depends on the yield at which the short was opened.
• An early short opened before yields rise can still be profitable despite a stop through.
• Dealers may establish positions closer to the auction deadline, making the final yield more relevant to their entry price.

Tags

# Treasury auction trading strategy (tails vs stop throughs)


# Treasury auction trading strategy (tails vs stop throughs)












All Treasury auctions stopped through this week across the 2, 5, and 7 year auctions. People are saying that dealers lost because dealers typically short then when-issued bond and cover at the auctions. If it stops through (high yield is less than when-issued yield) then dealers have to cover their short at a higher price.

I don't quite understand this logic. Assume for example that the dealer shorts the when issued bond at a yield of 1.5% in the morning. Yields rise throughout the day heading into 1 PM to 1.7% before the bidding deadline. The clearing/stopping yield was a 1.69% which suggests that the auction stopped through 1 basis point. So even though it stopped through, wouldn't the dealer still make out since they shorted at 1.5% and covered at 1.69%.

## Answer by dm63 (score 4)

https://quant.stackexchange.com/a/49387

Sure, in that situation the dealers would win. However it’s not a very realistic scenario. More commonly, dealers would set up short much closer to 1pm, in which case their entry price is around 1.70. Hence they would lose if the auction settled at 1.69.

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