MIAC Analytics is used by many leading firms in the mortgage industry to measure the price sensitivity of TBA securities. Measuring the price sensitivities of TBAs is a long-standing industry challenge, and industry thought leaders have adopted multiple methods for estimating TBA durations and convexities. MIAC Analytics supports multiple methods as well. The most accepted methods are constant OAS (Option-Adjusted Spread) and derived intra-coupon price spreads. The constant OAS method utilizes complex term structure models, calibrated to current long-term volatility, and empirically derived complex voluntary and involuntary prepayment models. Whereas AI-Durations/AI-Convexities utilize a more transparent and straightforward methodology. Given the CME Group TBA futures contract, market participants would strongly prefer a highly transparent method, this paper will describe the methodology used to derive the AI-Durations and AI-Convexities which are then converted to CME Group inter-commodity spreads.

AI-Durations are not the work of artificial intelligence, but simply the average of market implied durations. How does the market imply a duration? By simply measuring the intra-coupon price spread. For example, how much will the price of the TBA 5’s change if interest rates rally by 50 bps (lower bond equivalent yield or bond equivalent yields (BEY’s)? The presumption is that the TBA 5’s will move to be the current price of the TBA 5.5’s. And if the market sells off 50 bps (higher BEY’s), the TBA 5’s price will move to the current price of the TBA 4.5’s. The distinction and value-add of MIAC’s AI-Duration is in the method to derive the TBA prices themselves.

We have taken the prices and Al-Durations provided by MIAC Analytics and calculated a DV01 to provide a uniform risk metric in calculating our hedge ratios. Due to the TBA futures contract size having a notional value of $100,000, as with 10-Year Note futures, as a first step, we need to convert the price into notional terms by multiplying the price by $1000. Then, we can calculate the DV01 with the following formula:

DV01=$DV01= 0.01* (Dollar Price*(Duration in percent))

For example, on April 15, 2024, the 5.5% 30-Year UMBS TBA had a price of 97.3242 (in decimal terms) and a Duration/AI-Dur of 4.0347 Years or 0.040347 percent. Here is how to convert the dollar price and the AI-Dur into a DV01:

DV01=$DV01= $39.267=0.01*($97,324.22*(0.040347))

Since the beginning of 2024, CME Group has been using prices and AI-Durations provided by MIAC Analytics to calculate the DV01s for the ICS ratios. And, in contrast with the Treasury ICS ratios which are reviewed and published quarterly, they are reviewed and published monthly to be consistent with the risk in the TBA market. Please refer to the table below for the ratios for the Jul-24 TBA/Sep-24 ZN spreads and for the DV01s by coupon used to calculate the ICS ratios. Note that the 1:1 ratios will be added on June 17, 2024. The 1:1 spreads will have a minimum price increment (MPI) of ¼ of 1/32. They are expected to augment the spreads with the non 1:1 spread ratios.

^{*FTD of July 1, 2024}

^{*FTD of July 1, 2024}

Please refer to the table below of the correlations of daily returns of 10-Year Treasury Note futures and 30-Year UMBS TBA based on the rolling front month contract month in 2023.

^{Source: CME Group}

The 10-Year (TY) correlations ranged from 0.343 to 0.890. The 4.0% coupon produced the highest correlation. The 6.5% coupon produced the lowest correlation.

In 2023, the 55U/ZN spread demonstrated a high correlation of 0.8618. The current duration weighted ICS ratio is 3:2. The TBA 5.5% coupon results in a position of 3 contracts per spread (long/short). The 10-Year Note futures (ZN) results in an opposite (short/long) position of 2 contracts per spread.

In 2023, we reviewed days with strong correlation and weak correlation between these two markets. Suppose you were short the spread. Therefore, you would have been short 3 of the 55U and long two of the ZN. On the three-day period of strong correlation (9/27/23 - 9/29/23), you would have incurred a minor loss of $253 by being short the spread. On the day of weak correlation (3/22/23-3/23/23), during the banking crisis, you would have incurred a profit of $3921 by being short the spread.

Please refer to the table below for the profit and loss of the two periods described above.

^{Source: CME Group}

Please refer to the table below the correlations of daily returns of 5-Year Treasury Note futures and 30-Year UMBS TBA based on the rolling front month contract month in 2023.

^{Source: CME Group}

The FV correlations ranged from 0.306 to 0.861. The 4.0% coupon produced the highest correlation. The 6.5% coupon produced the lowest correlation.

Please refer to the chart below for the summary chart for the rolling nearby contract month for both TBA and Treasury futures.

Note that the bid/ask spreads of the implied ICS markets ranged from 0’03 to 0’045 32nds. The top of the order book is at least 10 spreads across the coupon stack. And the spreads with ratios of 1:1 have larger quantities at the top of the spread order book on CME Globex.

For example, the total margin requirement for a portfolio consisting of a long position in 10-Year Treasury Note (TY) futures and a short position in 30-Year 6% UMBS TBA futures (60U) is less than the margin requirement for a standalone long TY position. Using CME Group Clearing margin requirements on April 18, 2024 (given in the table below), the margin requirement for a long TY position is $2,656 per contract, while the total margin requirement of a portfolio that combines a short 60U position is:

($2,656 + $2,250) * (1 - 70%) = $1,472

For the 5-Year Treasury Note (FV) futures, the total margin requirement for a portfolio consisting of a long position in FV futures and a short position in 30-Year 6% UMBS TBA futures (60U) is less than the margin requirement for a standalone long FV position. Using CME Group Clearing margin requirements on April 18, 2024, (given in the table above), the margin requirement for a long FV position is $1,750 per contract, while the total margin requirement of a portfolio that combines a short 60U position is:

($1,750 + $2,250) * (1 - 60%) = $1,600

For additional deep margin analysis, use the CME CORE tool for single trades or complex portfolios.

With improved risk analytics from MIAC, implied pricing with ICS spreads, the addition of 5-Year Note futures to CME Group TBA ICS, and significant margin offsets, trading the mortgage treasury basis has never been easier.