A User's Guide to Enhanced 3-Year US Treasury Note Futures

What’s changed since the financial crisis and the initial launch of 3-Year Treasury Note futures in 2009?  Quite a bit for the Treasury futures complex. Treasury futures account for a much larger share of the daily risk transfer in Treasury markets ‒ having seen exponential growth in the institutional user base, trading volumes, and open interest. Investors have demonstrated a strong appetite for additional tenor points on the Treasury futures curve ‒ as evidenced by the success of the Ultra T-Bond (launched in 2010) and Ultra 10-Year Note futures (launched in 2016). Spread trading between Treasury futures has become more efficient with the rise of CME Globex-listed Inter-Commodity Spreads (ICS).

Exhibit 1: Comparing Today’s (2019) Treasury Futures To 2009

Source: CME Group

The Treasury futures complex has observed outsized growth in the adjacent 2-Year and 5-Year Note futures in recent years, suggesting pent-up demand for 3-Year Note futures. Effective July 13, 2020, pending regulatory review, CME Group is implementing three key changes to the 3-Year that it believes will enhance the contract:

• Reducing the minimum price increment
• Modifying the trade matching algorithm
• Expanding the deliverable grade

Contract Size And Pricing

3-Year Note futures are very similar to 2-Year Note futures in many respects. One contract is based on US Treasury notes having a nominal face value at maturity of $200,000. A price change of one full point results in a change of $2000 per contract.

The last trading day is the last business day of the contract month (Mar, Jun, Sep, Dec). 

The last delivery day is the third business day following the last trading day, which is the last business day of the contract month.

Minimum Price Increments

Following the successful implementation and the tick reduction benefits of the 2-Year Note futures in 2019, the 3-Year Note tick size is being reduced to enhance the price discovery process and reduce the cost of trading. The new minimum price increment (MPI) will be 1/8 of 1/32. The value of the new MPI will be $7.8125, which is 1/8 of 1/32 of $2000 (or $7.8125=((0.125*1/32)*$2000). Additionally, matching the 2-Year Note futures tick size will enable ICS spreading of the 2-Year and 3-Year at the smaller MPI.

Trade Matching Algorithms

The trade matching algorithm for outright markets will be 100% FIFO, which Is identical to the algorithm of all Treasury futures except for the 2-Year Note futures. The algorithm for the quarterly calendar spread is 20% FIFO/80% Pro-Rata, which is identical to the algorithm for all Treasury Note futures quarterly roll markets. Changing the outright matching algorithm to 100% FIFO is expected to be beneficial to the price discovery process, as it has in other Treasury futures markets.

Expanding The Deliverable Basket

Previously, the deliverable basket consisted of recently issued 3-year and aging 5-year Treasury notes with remaining terms to maturity of at least two years and nine months but not more than three years. After July 13, the deliverable basket of notes will include aging 7-Year notes with identical remaining terms to maturity (two years and nine months to three years).  Adding monthly 7-Year notes to the basket will increase the number of notes eligible from eight to 12 ‒ provided no reopened issues and an increase of 50%. It is projected to increase the cumulative face value from $319B to $550B by the Sep 2024 contract month.

Exhibit 2: 3-Year Projected Deliverable Basket, Pre- And Post- 7-Year Notes And May Refunding

Source: May Refunding Announcement

Allowing aging 7-year notes to be eligible will significantly expand the deliverable grade, making it similar to 2-Year and 5-Year Note futures, in terms of a number of issues and cumulative face value. The deliverable grade of September 2020 3-Year Note futures has been sorted by the nearest maturity date and by the highest coupon. The aging 5-year note with the 2-5/8% coupon (2-5/8s of Jun 2023) is currently projected to be the cheapest to deliver (CTD). The recently auctioned 3-year note (1/4 of Jun 2023) is expected to be competing for CTD status. The 1/4 of Jun 2023 matures on June 15, 2023 ‒ 15 days earlier than the aging 5-year and 7-year notes. We have assumed that the 3-year notes auctioned in July, August, and September will have the same coupon and issue size as the June issue. Please refer to the table below for Treasury notes eligible for delivery into the Sep 2020 contract, before and after the change. The second issue, the 2-5/8s of Jun 2023, is the projected CTD for the Sep 2020 contract. The current issues are labeled “3 yr”.  The “new” 7-years are bolded and labeled “7 yr”.

Exhibit 3: 3-Year Note Futures Projected Deliverable Basket, Sep 2020 Contract

*Assumes new 3yrs issued in Jul, Aug and Sep have same size and coupon as Jun issue.

To monitor the CTD status of Treasury futures, please refer to the Summary of Deliverables on our Treasury Analytics page.

Spreading Applications

The new and improved 3-Year Note futures are expected to fill a void on the Treasury futures yield curve. The relaunch of the 3-Year Note futures will enable several types of relative value spreading opportunities including ‒ but not limited to ‒ Treasury basis, yield curve, and credit. The 3-Year Note is very active on the BrokerTec platform. 3-Month Eurodollar futures have significant volume and open interest through the third year (green pack).

Expanding the deliverable grade to include aging 7-year notes is expected to enhance the liquidity of these notes and create the types of basis trading opportunities observed in 2-Year Note futures, where three types of original issues (2,3,5) are competing for CTD status.

Yield Curve Spreads

Treasury yield curve spread traders may establish positions such as 3/10 (TN) to express a view on the yield curve. They are likely to be most active in adjacent spreads like 2/3 and 3/5. And they might combine positions in these spreads to create butterfly spreads such as 2/3/5.  To get a better idea of how different these tenors are, please refer to the chart below-depicting 2-Year., 3-Year. and 5-Year. end-of-month par treasury yield curve data from 2008 to the present. 3-Year notes have been an issuance point for the Treasury since they began to issue them on a monthly basis in November 2007. The differences in rates and similarities in trends demonstrate why the 2-, 3-, and 5-year tenors have been complementary in the Treasury cash market. Similarly, Treasury futures are expected to be complementary as customers spread 3-Year Note futures against 2-Year and 5-Year Note futures as well as 3-Month Eurodollar futures.

Exhibit 4: 2-Year, 3-Year, and 5-Year Treasury Yields

Jan 2008-May 2020

Source: US Treasury Department

3-Year Treasury Note futures offer a rich array of predefined, implied inter-commodity yield curve spreads. Please refer to the table below for current spreads for the September 2020 contract. 

Exhibit 5: 3-Year Note Futures, Implied Treasury Spreads, Sep 2020 Contract

To monitor and learn more about Treasury futures yield curve spreads, please refer to the Inter-Commodity Spreads section of our Treasury Analytics tool from QuikStrike.

Cash Market Volumes

The distribution of Treasury cash market volumes further demonstrates the importance and complementary nature of the 3-year tenor. Based on 2019 Treasury coupon primary dealer statistics reported by the Federal Reserve Bank of New York (FRBNY), the 3-year produced a daily volume of $55B, which made it one of the most active tenors and represented 12.3% of the total ($442B). Please refer to Exhibit 6 for the 2019 Treasury coupon volumes by tenor.

Exhibit 6: 2019 Treasury Coupon Primary Dealer Volumes by Tenor, $ Billions

Source: Federal Reserve Bank of New York, Primary Dealer Statistics

Contract Specifications: 3-Year US Treasury Note Futures

CONTRACT UNIT	Face value at maturity of $200,000
PRICE BASIS	Points ($2,000) and fractions of points, with par on basis of 100.
MINIMUM PRICE FLUCTUATION	One-eighth of one thirty-second of one point ($7.8125, rounded to the nearest cent per contract), including inter month spreads*
PRODUCT CODE	CME Globex: Z3N CME ClearPort: 3YR Clearing: 3YR Bloomberg: 3Y
LISTED CONTRACTS	Three consecutive expiries in the March, June, September, and December quarterly cycle.
TRADING HOURS	5 p.m. – 4 p.m., CT, Sunday – Friday
SETTLEMENT METHOD	Deliverable
TERMINATION OF TRADING	The last business day of the contract expiry month. Trading in expiring contracts closes at 12:01 p.m., Central Time (CT), on the last trading day.
SETTLEMENT PROCEDURES	Treasury Settlement Procedures
POSITION LIMITS	CBOT Position Limits (Currently 35,000 contracts for the 2020 contracts)
REPORTABLE LEVELS	Reportable level of 750; Spot month accountability of 7,500 contracts
EXCHANGE RULEBOOK	CBOT 39
BLOCK MINIMUM	RTH: 5,000; ETH: 2,500; ATH: 1,250 contracts
PRICE LIMIT OR CIRCUIT	Price Limits
ALL OR NONE MINIMUM	All or None Minimums
DELIVERY PROCEDURE	Federal Reserve book-entry wire-transfer system.
LAST DELIVERY DATE	The third business day following the last trading day.
GRADE AND QUALITY	US Treasury notes that have an original maturity of not more than seven years and a remaining maturity of not less than two years and nine months from the first day of the delivery month but not more than three years from the last day of the delivery month. The invoice price equals the futures settlement price times a conversion factor plus accrued interest. The conversion factor is the price of the delivered note ($1 par value) to yield 6 percent.*
MATCHING ALGORITHMS	Outrights: FIFO (F)* Calendar Spreads: 80% Pro-Rata, 20% FIFO (K)

*Changes effective July 13, 2020, pending regulatory review

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