US Treasury Spreads: We’re Short For the Long Decline

The Big Bond Break?

The IMC blog initiated a couple of short positions on the yield curve yesterday. We shorted the 30-year bonds against the 10-year notes and we shorted the 10-year notes against the 5-year notes.

The short June T-bond/T-note spread was entered at 32-24. We are initially risking this spread to a two-day close above 35-19.

The short June T-note/5-Year note spread was entered at 9-03.5. We are initially risking this spread to a two-day close above 10-06.

June T-note 5-year note spread daily

June T-note 5-year note spread daily

Both spreads broke their mid-February lows, resulting in a lower correction low after a preceding bounce to a lower high. A lower high, followed by a lower low, is what we’d expect in a downtrend. Hopefully, this is the start of it.

Making It Complicated

As we pointed out at the end of the last post, a trader would not actually have both spreads on because the LONG 10-year in the first spread and the SHORT 10-year in the second spread would offset each other. This would simply leave you short the 30-year bond and long the 5-year note.

Although we are running both spreads for hypothetical purposes, a trader should focus on the one that best fits their own risk profile. The further out on the curve, the higher the volatility. So the T-bond/T-note spread is going to be more volatile than the T-note/5-Year note spread.

Now in the event that you want both spreads for diversification, you could short the T-bond and buy the 5-Year note. If one spread triggers the exit criteria but not the other, close out the contract that should have been exited (either the T-bond or the 5-Year note) and then put the T-note contract on to complete the remaining spread. Capisce?

Because We’re Optimists

Perhaps we’ve just entered the start of a big decline. If so, we’re going to want to squeeze all we can out of it. Therefore, we will need to find a spot to add to the short positions.

To recommend the ‘add-on’ positions, we’d like to see some setups where the spreads fall a bit, make a countertrend bounce that peaks either side of the initial entries, and the drops to new lows for the move.

If we’re lucky enough to see events unfold this way, we can move the initial liquidation parameters down to either side of the entry prices. This serves to eliminate most of the initial trade risk.

Another consideration is the use of price intervals where more spreads are sold in incrementally lower prices. The intervals would be based on the size of the countertrend moves as a proxy for volatility. We’ll cross that bridge if we come to it. For now, let’s just cheer for a drop in the Treasury market and pray that we get though Friday’s big unemployment report unscathed.


4 thoughts on “US Treasury Spreads: We’re Short For the Long Decline

  1. Most curve trades adjust for duration differences – DV01. So are you shorting 1 30 year contract against 2 10 years, and/or 110 year against 2 5 years?


    • Doug,

      Although it is a common practice to short the Treasury spreads according to the ratios that you mention, I am doing these on a 1:1 basis. It is certainly more volatile this way, but I like the way it seems to trend better.



    • Gary,

      We are still short. The exit criteria for the bond/note spread is a two-day close above 35-19. April 7th was the one day that the spread closed above this level before it backed off. We got lucky…so far.



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