• EFR review
• “Futures-unchanged”
• Difference between average price and legacy change-on-day
• Pack and bundle daily settlement prices/markers
• Technical differences
• Quoting yield-at-price

Short-term interest rate (STIR) futures are often cited as one of the primary sources of price discovery and as a result are commonly used to build interest rate projection curves. Due to the highly liquid nature of our STIR futures along with the anonymous central limit order book (CLOB), they are also one of the most efficient means of hedging or taking risk. Using these instruments to hedge is common against over-the-counter (OTC) interest rate derivatives, cash market positions and long-term interest rate (LTIR) futures such as our Treasury futures.

Over time, the hedging of interest rate swaps with futures contracts can lead to an accumulation of a risk known as “convexity risk.” Convexity risk arises due to the fact that STIR futures contracts have a fixed dollar value of a basis point (DV01), while interest rate swaps have a variable DV01 that changes with the level of interest rates. Since convexity is a second-order risk it is, in general, relatively stable and as a result tends to be relatively easy to hedge in liquid markets. However, some traders may wish to take an active view on the current level of convexity.

Exchange of futures for risk, or EFR, is a privately negotiated, off-exchange transaction involving the simultaneous execution of an exchange-traded futures contract (or contracts) and a corresponding OTC swap or other OTC derivative transaction with opposing risk. For example, long 2-year SOFR bundle, short (i.e., pay fixed) an equivalent quantity and maturity of an interest rate swap (e.g., SOFR overnight indexed swap). More details about EFR transactions can be found in the Market Regulation Advisory Notice associated with Rule 538. 

Traditionally in STIR futures, convexity risks have been managed by exchanging OTC swap positions for strips of STIR futures – either packs or bundles – via EFR trades as described above. Historically, some traders have referred to these packages as futures-unchanged trades.

In the past, when Eurodollars were the standard USD STIR contract and traded in the pit, packs and bundles of Eurodollars were quoted not based on outright prices but, rather, as a relative change to the previous day’s settlement prices. For example, if markets had moved up overnight a pack might be quoted at +3 ½ / +4 where that price represented the average move from the settlement price of the components of the pack or bundle. “Futures-unchanged” describes the market when all futures prices are at the previous day’s settlement price. That is to say, all contracts’ change-on-day are zero. An alternative description would be “using the previous day’s settlements.”

One characteristic of EFRs is that typically the execution of an EFR is agreed at current futures market prices. Those futures prices are prone to change during the negotiation of the EFR, though the spread between the price of futures and the related swap are more stable. It has become common to set the price of a swap based on an agreed set of futures prices and then adjust the swap price, if necessary, should the executed futures prices be different from the previously agreed prices. Since settlement prices are published by the exchange and known to both sides of a transaction, they have become the default agreed set of prices on which EFR trades are negotiated. As described above, those settlement prices are described by participants as “futures-unchanged.” 

Quoting of EFRs: One way that traders manage their convexity is via EFR trades, where they quote IMM-dated swaps with maturities matching a pack or bundle of futures. An example where a trader is posting a quote to offer (receive fixed) a swap covering the red months vs selling the equivalent risk in futures would look like the following:

“futures-unchanged, I will offer you the reds at 87”

Or

“Sell futures-unchanged vs 87 on the reds”

Should a trade be agreed, the next process to happen would be to execute and report the futures transactions, that is, for the counterparties to post the EFR to the exchange at the agreed prices (which are the current market prices). Once that has happened, the counterparties will adjust the price of the swap based on how far from unchanged the agreed futures prices are. Should futures prices be up by 2 basis points, the swap price will be moved down by 2 basis points and vice versa.

A common practice is to specify the range of futures prices over which the quote would be valid. This is because the level of convexity is in some part derived from the level of interest rates, meaning, while a quote that is valid when futures are unchanged may also be valid when futures have changed by a small amount, it may not be valid if futures have moved by substantial amounts from the previous day. For example, a quote may be deemed to be valid at futures prices that are between +/-5bp from unchanged.¹

Packs and bundles are no longer quoted in reference to their change-on-day prices. Since the introduction of SOFR futures, packs and bundles have been quoted as the average price of the constituent legs. See this paper for full details of average pricing. This provides a number of advantages over the legacy approach. Orders can now be placed on a “good ‘til canceled” (GTC) basis, which is particularly useful if one is working passive orders in spreads of packs or in butterflies where price volatility is lower. Since packs are now quoted as a single price representing the average of constituent legs this allows for calendar spreads of packs and butterflies to work in exactly the same way as spreads and butterflies of individual contracts. This more intuitive representation also removes the necessity to convert an observed set of prices into change-on-day, thereby removing an operational risk.

Packs and bundles have daily settlement prices that are used as references for the purpose of calculating their change-on-day. These daily settlement prices are not used for clearing purposes, only as reference prices. Once traded, each leg of a pack or bundle is settled vs. the daily settlement price for that specific leg. It may be helpful to think of the pack or bundle prices solely as end-of-day markers in order to distinguish from the prices used in clearing.

The average of the previous day’s settlement prices for any pack or bundle can, and often does, sum to a non-valid tick price. The result is that, when a pack is trading at a change of day of, for example, +2bp, that does not imply that each leg of the trade will also be +2bp to its own leg settlement price from the previous day.

This nuance can be best explained by way of an example:

Note that the average of the individual legs is not a valid on-tick price. The pack’s reference settlement price is rounded to the nearest valid tick price – in this case 97.1175. If the June 23 pack trades at 97.1375, that would constitute  a +2bp move on the day. The leg assignment prices for such a trade are shown below:

The consequence of this change is that the available set of executable prices for packs and bundles is always the same: quarter-tick intervals beginning at zero, for example, 97.1000 / 97.1025 / 97.1050 / 97.1075 / 97.1100 / etc.²

Yield-at-price quoting is very common when trading related products. It is best described by example, similar to the one above:

“87 offer red pack swap vs 11.75 futures”

Or

“Sell red pack futures at 11.75 vs 87 on the swap”

In both cases, readers will recognize that the full, larger figures are implied:³ The full price/yield would be 97.1175 vs 2.87%. Convexity accounts for the difference between the swap yield and the yield implied from the futures. (i.e., 100 - 97.1175 = 2.8825% vs 2.87%) 

Having set a starting point, traders are still able to adjust the swap price if the cross of futures is executed marginally away from the original quote. This quoting method removes any doubt about the starting point that may exist due the technical changes noted above in respect of futures-unchanged. 

While futures-unchanged trading style is still available, this note aims to clarify for all participants the implications of changes related to average pricing. 

Participants may decide to continue to trade futures-unchanged and adjust the price of the pack or bundle from its settlement marker. But, as we have explained above, this would not necessarily result in all leg prices being unchanged.

Legacy “futures-unchanged” remains available, but technically not as a pack or bundle price. Should participants need to trade at exact settlement prices across the strip, that can be achieved as long as the transaction meets block eligibility levels. In that case the transaction can be submitted as a package where each leg is at clearing settlement prices, or at levels where all components are equally adjusted from the clearing settlement prices.

1. 5bp is an arbitrary magnitude used to describe the effect, rather than an indication of the most appropriate range
2. Previously the increments were also quarter tick but the start point was variable depending on settlement prices of individual legs to each pack or bundle: 97.118125 / 97.120625 / 97.123125 / etc.
3. That is to say, the verbal quote omits part of the prices / yields that are being proposed; using context clues to inform the full meaning: 87 → 2.87% and 11.75 → 97.1175.