Trading the "Long Gilt Futures March 2012"

katy123

2 Questions.

A. Is the long gilt futures market efficient and has little or no price discrepancies between the cash prices and the futures market (one would think it is as I read it is very liquid market). But its gets complicated because it uses a notional bond and have price converstions.

B. And the other question is does the usual issues of contangion/backwardation apply to this market like the oil market. If this does, then one should rollover in a backwardation market (assuming you are shorting) and don't rollover in a contango environment (again assuming u are shorting). Is this all correct

Thanks.

Nomad2006

The sterling bond market is huge with tight bid-offer spreads so any discrepancy between bond and futures prices will be quickly arbitraged away. As you say the contract relates to a theoretical bond but will track the cheapest to deliver 'real' bond closely (with a well understood price adjustment). Remember bond futures are physically settled, ie if you hold to matuity you will have to take delivery of an actual gilt.

The bond future will have a 'cost of carry' equivalent to the difference in yield on the underlying bond and the overnight repo rate you would expect to finance the bond at. In a normal upward sloping yield curve environment such as we have today, being long the future would give you positive carry (so when you roll you repurchase at a lower price), but if the yield curve were to invert (short term rates higher than long term) then you would see negative carry.

Hope this helps!

katy123

Nomad, many thanks for your detailed reply, 2 further question if I may

A. is the gilts market 99% of the time upward sloping?

B. Your rollover example is assuming one is going long, in my example, I am shorting, so when rolling over to a higher yield (normal upward slope) = lower price therefore a gain during rollover for a shorter.....is this correct? Hhmmm...kinda confusing.

97trophy

katy123 wrote: »

I am shorting, so when rolling over to a higher yield (normal upward slope) = lower price therefore a gain during rollover for a shorter.....is this correct? Hhmmm...kinda confusing.

No, you "pay" to be short Gilts at the moment.

afwone

After a year or so of reading posts on this forum, I have become smug at what I know, and have started clucking to myself at just how naive and ignorant some posters are in matters of finance.

On this thread I am one of the clueless ones, and am left marvelling at words, phrases and concepts that I haven't heard before.

Thanks for showing me how much there is left to learn!

Nomad2006

97trophy wrote: »

No, you "pay" to be short Gilts at the moment.

Correct - if you are short, then your roll from the March to June future will be buying March (to close your March short) and selling June to reopen the short. Since March is more expensive than June, you are buying and high and selling low, so you pay to roll.