Fundamentals aside, bond CFDs also provide traders with a compelling trading environment through which to deploy their trading strategy, with highly liquid top-of-book pricing, low gapping risk (US bonds trade almost 24 hours a day), good movement and low drag from trading costs.
Like many of Pepperstone’s spread-based markets, Pepperstone’s bond CFD offering will be priced off the front-month bond futures. Our LP then adjusts the price to remove the net financing cost (or cost of carry) from the current period to the futures expiration to create a cash price.
This typically means our cash bond CFD price will be lower than the futures price, where the difference is called ‘the Basis’ or ‘fair value’.
As each day passes and gets closer to the futures expiration, the lower the basis – subsequently, we see the cash and futures converge over time.
If a client subsequently holds a cash CFD bond position over the rollover time they will pay/receive the swap charge depending on whether they are long or short.
Underlying (real) cash bonds will have a capital component, where bond traders can buy and sell to speculate on price moves – however, market participants will also be positioning portfolios to receive income from the bond’s coupon (if long).
Traders should make the distinction that bond CFDs are used by traders to trade price moves and there is no consideration for fixed interest or the coupon.
Given that Pepperstone bond CFDs price is derived from the futures pricing, it is worth understanding more about these markets.
Traders use bond futures to speculate or hedge a physical bond exposure/portfolio. Pepperstone clients can use bond CFDs to hedge, but far more commonly bond CFDs are vehicles to trade price moves and to speculate and react.
Bond futures will track closely to the same maturity (real) cash bonds. Predominantly because if the position is held past the future's expiration date this is what the seller will have to deliver if the buyer chooses to take delivery of the underlying. Once the buyers have the underlying cash bonds delivered, they will then get all the income from the bond's semi-annual coupon, plus any capital move from the changes in the price ongoing.
The seller of the bond futures is obligated to give the buyer the underlying physical bonds after expiration.
Bond futures are settled with physical delivery and not cash settled like many futures products, which is why most futures trading brokers put an automatic roll instruction on client’s accounts.
Pepperstone’s bond CFDs work in a similar manner – whereby, close to the bond futures expiration date the LP will move to take the price from the next quarterly futures contract and provide a cash price from this. This should affect the cash bond CFD price given the fair value adjustment.
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