how bond futures work
a futures contract is an agreement entered into by two parties one party agrees to buy and the other agrees to sell an underlying asset at a predetermined price on a specified date on the futures contract s settlement date the seller must deliver the asset to the buyer a futures contract s underlying asset could be a commodity or a financial instrument such as a bond bond futures are contractual agreements where the asset to be delivered is a government or treasury bond a bond futures contract can be held until maturity and it can also be closed out before the maturity date if the party that established the position closes out before maturity the closing trade will result in a profit or a loss from the position depending on the value of the futures contract at the time bond futures are standardized by the futures exchanges and are considered among the most liquid financial products a liquid market means that there are plenty of buyers and sellers allowing for the free flow of trades without delays as such the bond futures contract is used for hedging speculating or arbitrage purposes as mentioned earlier the seller of the bond futures can choose which bond to deliver to the buyer counterparty the bonds that are typically delivered are called the cheapest to deliver ctd bonds which are delivered on the last delivery date of the month a ctd is the cheapest security that s allowed to satisfy the futures contract terms the use of ctds is common with trading treasury bond futures since any treasury bond can be used for delivery as long as it is within a specific maturity range with a specific coupon or interest rate futures traders typically close positions well before the chances of delivery in fact many futures brokers require that their customers offset positions or roll to later months well before the futures expiration many futures contracts require margin meaning a trader needs to deposit and maintain a specific amount in their brokerage account this amount is generally much smaller than the notional value of the futures contract and it must be deposited when a futures position is opened a broker requires an initial margin and a maintenance margin should the bond futures position decline sufficiently in value the broker might issue a margin call which is a demand for additional funds to be deposited futures margin differs from securities margin in futures trading margin is the amount that must be maintained in the account it does not fund your purchase and it does not create a leveraged position it is based on the underlying asset s price and is used as a bond to ensure both parties can meet their obligations at expiry the risk of trading bond futures is potentially unlimited for either the buyer or seller of the bond risks include the price of the underlying bond changing drastically between the exercise date and the initial agreement date also the leverage used in margin trading can exacerbate the losses in bond futures trading 