For those familiar with the Treasury futures calendar spreads, the pricing and execution of TBA calendar spreads, aka “rolls,” are identical. The spread price is quoted as the front month price minus the deferred month price. If you are buying the spread, you are buying the front month and selling the back month. For example, on May 31, 2023, the June 5.5% (55UM3) had a mid-market of 99.80, and the July 5.5% (55UN3) had a mid-market 99.789. The calendar spread/roll market had a bid/offer of 0’002 (0-00 1/4 )/0’003 (0-00 3/8).

30-Year UMBS calendar spreads on CME Globex have a minimum price increment (MPI) of 1/8 of 1/32. However, they can also be executed at an MPI of 1/16 of 1/32 as a block trade that is submitted to CME ClearPort. They benefit from implied pricing being enabled with outright coupon markets. Futures calendar spreads have a leg ratio of 1:1. Each spread position requires initial margins of $660.

For the Jun-23/Jul-23 roll markets on May 31, 2023, one week before the expiration of the Jun-23 contracts on June 6, 2023, the TBA roll markets were trading on CME Globex at a bid-ask spread of 1/8 across the coupon stack (with the exception of the 2.0% and 6.5% coupons, which do not currently trade). At tight spreads and with about 40 contracts at the top of the order book, the market provided ample opportunity to roll positions from Jun-23 to Jul-23. For example, in the screenshot below, the roll market for the 4% coupon had a bid price of -0-02 3/8 and an offer price -0-02 1/4. 

Block trades in TBA roll markets may be executed at increments of 1/16 with submission to CME ClearPort achieved by splitting quantities 50/50 across price levels of 1/8: 

• 55UM3 99-263 (99 price points and 26 3/8 (6/16) 32nds)
• 55UN3 side is booked with quantity equally split across two price levels. In our example, half at 99-301 (1/8) and half at 99-302 (2/8) for an average of 99 price points and 30 1.5/8 (3/16) 32nds

The minimum trade size for a block trade of 30-Year UMBS TBA Futures is 100 contracts during regular trading hours (RTH), 50 contracts during ETH, and 25 contracts during ATH. Block trades of 30-Year UMBS TBA futures must be reported to CME within 15 minutes.

Block trades must be submitted to CME ClearPort within 15 minutes of execution. 

Continuing with our example of the roll market for the June 5.5% (55UM3)-July 5.5% (55N3) futures calendar spread, please refer to the figure and/or boxes below for the relevant dates and settlements. Note that the roll seller is delivering MBS pools for the front month (Jun-23) on June 13, 2023. The roll seller is receiving MBS pools for the back month (Jul-23) on July 13, 2023. These are the settlement dates for Jun-23 and Jul-23 for Class A, 30-Year UMBS.

A TBA “dollar” roll transactions consists of two TBA trades. The “roll seller” sells an MBS in the front month and simultaneously buys an MBS in the subsequent month TBA contract with the same TBA characteristics, at specified prices. In particular, the two MBS pools delivered into the two TBA contracts need not have the same CUSIP, as long as they have the same TBA characteristics.

The “drop” of this TBA dollar roll, defined as the price difference between the front- and future-month contracts, is positive for two reasons. First, and most importantly, the returned MBS pool in the future-month TBA contract may have an inferior prepayment behavior, and hence, lower value than the original MBS sold in the front-month contract. Second, after the front-month leg of the dollar roll transaction, the roll seller gives up the ownership of the MBS and any interest and principal payments. These two features, especially the redelivery uncertainty of the returned MBS pool in the future-month leg, differentiates the dollar roll from an MBS repo transaction. In an MBS repo trade the same MBS pool has to be returned, and the original owner collects principal and interest during the term of repo.²

Using a proprietary dataset, Song and Zhu have provided the “first” analysis of dollar roll “specialness”, the extent to which implied dollar roll financing rates fall below prevailing market rates. Dollar roll specialness increases in adverse selection and decreases in MBS liquidity. Specialness is also negatively related to expected MBS returns. Moreover, the Federal Reserve’s MBS purchases and dollar roll sales are associated with lower specialness. Please refer to the links below for their analysis of dollar roll specialness.³

In our analysis below, we have provided returns from the perspective of the TBA roll buyer over the two-month period of the two contract months being listed. For example, the Apr-23/May-23 spread began on February 7, 2023, the first trade date for the May-23, and was hypothetically closed on April 4, 2023, the day immediately preceding the last trading day for the April-23 contracts.

Due to the small sample sizes, five and four, and the lack of a drop in a few instances in the futures roll, larger sample sizes are recommended for a more comprehensive assessment of the returns of the TBA roll. In our limited history, three of the five rolls for the initial coupons, 2.0% to 5%, produced positive returns, and two of the four rolls for the higher coupons, 5.5% and 6.0%, produced positive returns. The 6.5% was not included because the first contract month was May-23. Here are at least six risks that may impact the drop in the TBA roll market:

1. Changing interest rates
2. Prepayments go up
3. Term rates go up
4. Volatility goes up
5. Curve flattens
6. Mortgage spread widens

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

Source: CME Group

The order book liquidity in the TBA monthly roll has improved significantly in recent months. Please refer to the charts below for the average bid/ask spread and average top of book. These charts reflect an average of the “current” coupons, the 5% and 5.5% for the last five trading days of the nearby expiring contract month for each roll since launch. From the May-23/Jun-23 roll to the Jun-23/Jul-23 roll, the average top of the order book has nearly doubled, increasing from 22 to 42 contracts.

Meanwhile, the average bid/ask spread for the 5% and 5.5% coupons has been less than 2/32 for six of the seven rolls (Dec-22/Jan-23, Jan-23/Feb-23, Feb-23/Mar-23, Mar-23/Apr-23, May-23/Jun-23, Jun-23/Jul-23). The spread widened to about 4.5 (32nds) during the Apr-23/May-23 roll as market volatility was elevated from the banking crisis. The spread narrowed back to less than 1/32 for the May-23/Jun-23 roll, and it continued to tighten for the Jun-23/Jul-23 roll, which had an average spread of less 1/2 of 1/32. Recall that each tick is very small at 1/8 of 1/32.

The charts below demonstrate the narrowing of the bid/ask spread (light blue line) over the course of the month and the top of the book (dark blue bars) averaged at least 32 contracts (notional value of $3.2M) in all instances for the 5% and 5.5% coupons. The 5% coupon produced the deepest average top of book of 83 contracts (notional value of $8.3M) on May 19, 2023. The bid/ask spread and the top of book data are the Jun-23/Jul-23 calendar spreads from the month of May 2023 (May 1-31) for the 5% and 5.5% coupons. The order book data reflects regular trading hours, which are 7:00 a.m. to 4:00 p.m. CT on CME Globex. Bid/ask spreads are in 1/32 format. Minimum tick of 1/8 of 1/32 is equal to 0.00390625 (=1/8*1/32=0.125*0.03125)

1. TBA Trading and Liquidity in the Agency MBS Market, James Vickery and Joshua Wright, FRBNY Economic Policy Review, May 2013 https://www.newyorkfed.org/medialibrary/media/research/epr/2013/1212vick.pdf
2. Mortgage Dollar Roll, Zhaogang Song, The Johns Hopkins Carey Business School; Haoxiang Zhu MIT Sloan School of Management, February 3, 2016, Section 2.2 Dollar roll, pgs. 9-10 https://www.atlantafed.org/-/media/documents/news/conferences/2015/1210-real-estate-finance/zhaogang.pdf
3. Mortgage Dollar Roll, Song, The Johns Hopkins Carey Business School; Zhu MIT Sloan School of Management, February 3, 2016, Abstract, pg. 1 https://www.atlantafed.org/-/media/documents/news/conferences/2015/1210-real-estate-finance/zhaogang.pdf