CME Joins Battle for Retail Bond Traders With Micro Futures

CME Group Inc., whose Treasury futures already dominate among pros, is now trying to lure small traders by offering simpler-to-understand contracts that focus on the numbers the masses care most about anyway: yields.

The contracts, when they begin trading on Aug. 16, will rise when Treasury yields increase and fall when they decline -- whereas the existing futures move in the same direction as bond prices, a byzantine turnoff for many investors. The Micro Treasury Yield futures, which will compete with a similar set of products introduced last year by The Small Exchange, will come in 2-, 5-, 10- and 30-year versions. Their $10-per-basis-point price increment is much smaller than CME’s professionally targeted contracts and more digestible for retail traders.

The yield futures are “much easier to absorb,” said Sean Tully, CME’s global head of financial and over-the-counter products. They may even appeal to investment professionals outside of fixed income, he said. For example, customers can position for a change in the shape of the yield curve, and “they don’t have to worry about the complexities that professionals know and love.”

This is CME’s latest attempt to win over smaller investors, following miniaturized versions of its popular S&P 500 contracts, as the Chicago-based company seeks to expand beyond its historically institutional customer base. Individual investors are wielding increasing influence in markets, especially in stocks and cryptocurrencies, amid the meme revolution.

While CME’s main Treasury derivatives are a behemoth whose combined volume rivals trading in actual Treasury notes and bonds, the way the futures work is anything but simple.

Old School Ways

The conventional contracts track the cheapest security in a group, whose prices are adjusted to levels consistent with an anachronistic 6% coupon rate, in relationships governed by the cost of borrowing the cash note or bond. The cheapest securities deliverable into the main Treasury futures contracts aren’t usually the new issues investors are familiar with. For example, the front-month 10-year note futures contract for September 2021 currently tracks the 10-year note issued in May 2018, with seven years left to maturity.

CME didn’t invent Treasury futures that move in lockstep with yields. A nearly identical set of products was introduced in December by The Small Exchange, a specialist in miniaturized financial products whose backers include trading giants Citadel Securities and Jump Trading Group. Its contracts for 2-, 10- and 30-year Treasuries are settled based on yield data provided by MarketAxess Holdings Inc. CME is referencing new-issue yields from its competing BrokerTec trading platform.

Don Roberts, president and CEO of The Small Exchange, said its Treasury products remain “a capital-efficient alternative” to CME’s because its combined fees and margin requirements will be lower.

Tully said CME is uniquely positioned, based on its size, to offer customers hefty margin offsets. For example, a trader with opposite positions in products that have highly correlated price moves can potentially offset 80% of the required margin for the combined positions. Roberts said The Small Exchange is developing margin offset capability.

Open interest in The Small Exchange’s Treasury contracts was about 2,000 contracts on June 25, compared with about 13.7 million across CME’s seven main Treasury futures contracts.

Less Capital at Risk

CME’s micro-products are a way to gin up interest in trading Treasuries despite historically low yields by affording non-professionals a way to get involved without putting huge amounts of capital at risk for little reward. While borrowing to fund pandemic relief caused the Treasury market to balloon in size -- to over $21 trillion from $17 trillion in March 2020 -- the 10-year note’s yield remains near 1.50%, which was breached in 2012 for the first time in a generation.

“Even though rates are very low, you have enormous potential risk in the market,” Tully said. That’s driven growth in CME’s longer-maturity Treasury futures, he said, while shorter-maturity contracts have languished with U.S. monetary policy rates set near zero. “The reason is the amount of debt that needs to be hedged is unprecedented.”

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