A New Exchange for Small Traders Has Turned U.S. Treasuries Upside Down

A fledgling futures market backed by Chicago trading giants including Citadel Securities just rolled out a contract that turns the U.S. Treasury market on its head.

The Small Exchange product rises when the yield on 10-year notes increases, and falls when the rate decreases. That’s novel. Although investors globally fixate on Treasury yields, the dominant derivatives they could previously buy track the inverse: the price of bonds.

The new Chicago-based exchange listed its first products in May and is focused on different customers than the dominant incumbent, CME Group Inc.: small traders, rather than large professionals, although there’s nothing to stop the whales from playing, too.

For many amateurs, if the sheer cost of transacting in bonds and regular futures isn’t a deterrent, the babble of whole numbers, fractions and plus signs that make up Treasury quotes might be. The Small Exchange circumvents that, using the figure that happens to matter more to investors anyway.

“This is the first time a future’s been launched in yield versus price terms,” Small Exchange Chief Commercial Officer Peter Mulmat said in an interview. “We think that simplicity will really resonate.”

The Treasury contract is the fifth introduced by the Small Exchange during its short life. The others allow leveraged bets on U.S. equities, the dollar and precious metals. Customers need far less money to trade them as compared with similar contracts at CME.

So far, business has been modest, with average daily volume at the exchange under 2,000 contracts. But the company’s timing is potentially auspicious. Throughout the pandemic, retail trading of stocks has zoomed higher; the sort of traders coveted by the Small Exchange have had a busy 2020.

Read More: Retail Continues to Drive U.S. Equity Market

And the company’s investors -- which in addition to Citadel Securities include Jump Capital, Peak6 Investments and Interactive Brokers Group Inc. -- could give the exchange a leg up. Citadel Securities is a major Treasuries trader. Jump Capital is affiliated with Jump Trading. While buying and selling at CME is anonymous, making exact figures impossible to assess from the outside, Jump is widely considered among the largest traders at that exchange. Peak6 is one of the bigger trading firms in Chicago. And Interactive Brokers has a large customer base among retail investors.

The Small Exchange innovation brings “bond-directional views to the masses,” by “taking away the confusion and the technical aspects” of bonds and bond futures, said George Goncalves, an independent strategist.

He said the smaller contract sizes fit with the recent theme of “the miniaturization of everything financial,” such as CME’s lower-value “micro” version of its S&P 500 futures franchise. “We like to take bets, and smaller sizes help,” Goncalves said.

Smaller-dollar contracts may have appeal even to pros. And there’s a sign the Small Exchange could have bigger firms in mind. Last year, it announced the computers that run its market would live inside the same CyrusOne Inc. data center in Aurora, Illinois, that hosts CME. Every major trader already does business within that facility’s walls because big price moves in global markets tend to happen there first.

The Small 10YR US Treasury Yield product, introduced Monday, references an index value that equals the most recently issued 10-year note’s yield times 1,000. Based on Monday’s closing yield of 0.927%, that was 9.27. MarketAxess Holdings Inc. provides the yield data.

As with all of the company’s products, the contract size is 100 times the index value, with a tick size of 0.01 and tick value of $1. A single contract is worth $927 when the 10-year yield is 0.927%, and that value would rise by $10 if the yield climbed to 0.937%. Initial margin, or the collateral traders need to post when buying, is only $180. The contracts are cash settled on the third Friday of the month.

All those numbers are bigger at CME, whose Treasury futures have a contract size of $100,000 in most cases. The minimum price increment for CME’s 10-year note contract, half of a 32nd of a price point, is worth $15.625. Initial margin is currently at least $1,400.

“We built this exchange with the retail, self-directed trader in mind,” Mulmat said. “It affords people the efficiency of futures, while getting exposure in the appropriate size.”

Eventually, the Small Exchange may add more products tracking different Treasury maturities, making possible “very interesting, simple yield curve trades,” he said.

©2020 Bloomberg L.P.

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