Bonds
The next biggest market in the global marketplace after forex trading is bonds, namely the US Treasury Bond (T-Bond). Governments issue bonds to raise money and finance government spending and investors buy them to receive interest on what is effectively a loan to a ‘safe’ borrower such as the US government.
A bond is essentially an IOU. However, it is an IOU which can be bought and sold in the bond market. It represents a ‘chunk’ of sovereign or corporate debt. Many financial bookmakers will accept bets based on the rising or falling value of bonds. In particular, following the 10-year USA Treasuries, German bunds and the spreads between them and other sovereign debts is important as these are a measure of the relative safety of different countries for investment purposes.
Bonds spread betting can be a lucrative market, although you should gain a little knowledge of how bonds work and shadow your chosen markets first before placing a bet.
“You generally need access to the futures markets to short bonds, though in the UK we have the lovely spread-betting as well. It’s not an area for the non-professional IMO. One problem is the speed of some of the moves in the debt markets. It is far safer to play the inflation/currency depreciation trade by going long of gold and gold equities though. You can then only lose half your shirt instead of having to buy a whole new wardrobe ;)”
A bond usually has a face value which will be paid by the issuer (the borrower) on a certain date. When the bond is paid off the issuer is said to have redeemed the bond. Note however that perpetual bonds are never repaid, index-linked bonds do not repay a set amount but are, literally, index-linked and callable bonds do not have a fixed repayment date. The amount of time between a bond being issued and being redeemed is known as the bond’s maturity period. Some bonds pay interest. Bonds are normally issued at par, although deep discount and zero-coupon bonds are sold for less than their face value.
Bonds are also known as notes and bills. Generally bills have a maturity of less than one year, notes have a maturity of 1-5 years, and bonds have a maturity of over 5 years. US government bonds are an exception to this – notes go up to 10 years and bonds are for 30 years.
There are two types of bond market. The primary market is where borrowers issue bonds. The secondary market is where ‘second hand’ bonds are traded after they have been issued.
The main factor affecting the value of bonds and which you need to be aware of when betting on them is fluctuating interest rates. When interest rates rise the values of bonds tends to go down. When interest rates fall they tend to go up. However, other influential factors can include the chance of the issuer defaulting on the repayment of the bond.
Key bond markets include :
- British Government Stocks – UK Gilts
- US Treasury Bond – Long Bond or Long Gilt
- German Government Bond – Bund
- Spanish 10 Year Notional Bond
- Japanese 10 Year Bond – JGB
- Euribor Spread Betting
However, in August, IG Index capitalised on spread betters’ increasing interest in bonds and started offering the option to trade the BTP Italian bond contract. The company has experienced a phenomenal increase in the number of deals involving Italian bond trading last November 2011 as the Italian bond yields hit crisis levels. The German bund has also been a particularly busy market for spread betting providers in 2011 since it is often seen as a safe haven.
Spread Betting Bonds
Spread trades on government bonds are also made using exchange-traded futures contracts. Spread betting providers offer spreads on futures prices for the long dated US Treasury bond, the 10-year British gilt-edged stock, the 10-year Japanese JGB and the 10-year German bund. A key difference between buying a foreign government bond outright and making a spread trade on a foreign government bond future is the extent of currency risk.
Buying a foreign bond in the conventional way exposes investors to changes in the exchange rate between their home currency and the foreign currency concerned on the full value of their exposure.
Making a spread trade on a foreign bond however will involve no exchange rate risk at all, if the bet is denominated in the home currency.
If it is denominated in US dollars or another overseas currency, then the eventual size of the British Pound’s profit or loss will be affected by movements in the exchange rate. But whether the bet makes a profit or a loss will not be.
A chart of US 10 year T-bonds from 2006
Due to the tight spreads and volatility, this is a financial instrument that is suitable for day traders and also for trying to spot trends and run trading positions for days or weeks. German bonds and Euribor are offered from 07:00 until 18:00, short Sterling is offered from 07:30 until 18:00 and the US long bond is offered from 07:00 until 20:00. Bond markets can be very volatile and for instance, the German bund has gone up 2,000 points since its April 2011 lows with a 600 points risk in just three weeks in November.
With these markets, it’s not sufficient to be abreast of the technicals, you also have to be versed on the fundamentals and political risk and one problem is that some of the decisions are taken over a weekend. This could lead to substantial gapping from Friday close to Monday opening.
A number of spread betters are trend followers who try to capitalise on a trend believing that it will continue such as weakness in Italy. Others are contrarians and prefer to take an opposite view when they believe that market sentiment is overdone. Of course instead of taking a direct position on the debt markets you could instead take a position on the euro 🙂
Joshua Raymond, chief market strategist at City Index, says: “Spread betters are by their very nature quite opportunistic traders, so when volatility surrounds a particular market, as it has with bonds in 2011, this would usually attract a greater amount of spread betting activity, with clients attempting to profit from quick moves in a short space of time.”
Example of a Spread Bet on Bonds
- Otto Optimist uses a trend following system that indicates a downtrend in Treasury bond prices may be occurring.
- His bookmaker is offering a spread of 10216-10221 on the March T-bond. Otto makes a £20-a-point down-bet from 10221.
- Otto was right. A series of disappointing inflation figures and a sharp fall in the dollar force the bond markets to become more pessimistic. The spread on the March T-bond falls to 10011-10016.
- Otto decides to close out the bet. His profits are £1280 (10216 minus 10016, times £20).
- Note that Treasury bond futures are expressed in thirty-seconds of a point, so that the next number after 10031 is 10100, not 10032.