Product innovation and democratization of access at CME Group has led to the futurization of the traditional OTC equity swap with the advent of Adjusted Interest Rate Total Return futures (AIR TRFs). This paper dives deeper into the AIR TRF product by observing CFTC positioning and looks at a curve trade example. Figure 1 illustrates the adoption of Adjusted Interest Rate Total Return futures (AIR TRFs). Through Q3 2024, ADV grew to 10.2K contracts, +109% vs 2023 across all AIR TRF products. Also, as the market has matured, Globex’s share of trading has also grown from near zero to ~20% on screen

CORE is a recommended tool to best understand the total portfolio margin impact of any trade at CME Group. For a better understanding of SPAN2, watch this Clearing House Webinar from August 2024. Further, our Advisory Notice is useful in providing a step-by-step guide for entering a portfolio into CORE.

CME Group has written extensively about the benefits of central clearing and reducing client capital costs. Since exploring the Final UMR Phases in 2022, capital costs for bilateral derivatives have remained punitive. Figure 2 shows that bilateral equity index swap margins remain at multi-year highs ahead of ISDA’s anticipated next announcement in December 2024.

As highlighted in the below chart, the bilateral up front of 19% relative to roughly 5% on Adjusted Interest Rate Total Return futures (AIR TRFs) offers listed derivative users tremendous capital savings as an OTC swaps replacement. This suite of swap-like futures’ success story is exemplified in the open interest growth highlighted in the introduction.

The other interesting aspect is the margin offsets received when dealing in calendar spreads.  AIR S&P 500 Total Return (EFFR) futures have roughly the same initial margin as a E-mini S&P 500 contract and preferential margin offsets are produced when traded as a spread. This will be discussed further in the following sections.

Weekly CFTC positioning metrics are some of the most tracked financial data points in the world, as they denote the level and the type of activity by various market participants. CFTC defines three of the participants as follows:

1. Dealers/intermediaries as participants typically described as the “sell-side”

2. Asset managers as institutional investors, including pension funds, endowments, insurance companies, mutual funds and those portfolio/investment managers whose clients are largely institutional

3. Leverage funds as commodity trading advisors (CTAs);registered commodity pool operators (CPOs) or unregistered funds who’s trading strategy involves taking outright positions or arbitrage

The largest open interest positions for the AIR TRF complex are on the S&P 500 Total Return (SPTR) index, with $165B of futures open interest as of June 2024 quarter end. It is interesting to note the behavior of the product’s users and compare that to our adjacent equity markets.  The CFTC Commitment of Traders tool reports dealers (Figure 3a) were net long 40,165 contracts ($11.2B) on July 9.  The other side of the trade, almost representing a mirror image, were largely leveraged funds (Figure 3b).

Another statistic that stands out in Figure 3a and 3b is the amount of spreading that occurs, highlighted in the red box. CFTC defines “spreading” as offsetting long and short positions held by a trader in different calendar months. Any residual long or short position is reported in the long or short column. Further, inter-market spreads (i.e. E-mini S&P 500 (ES) futures vs. Adjusted Interest Rate S&P 500 Total Return (EFFR) futures) are not considered.

When observing the $594B open interest positioning of E-mini S&P 500 (ES) futures, Figure 4a and 4b are almost a mirror image. CFTC reports dealers (Figure 4a) were net short 771,001 contracts (~$215B) on July 9.  

Interestingly, the offsetting E-mini S&P 500 (ES) long positions are largely asset managers  (Figure 4b). This is the zero-sum gain feature of derivatives. For every buyer, there is a seller and vice versa. This is not to say dealers are actually net short E-mini S&P 500. Dealers hold offsetting derivative positions or other financial instruments, such as long AIR S&P 500 Total Return futures.

It is also interesting to note that E-mini S&P 500 (ES) calendar spreads as a percentage of open interest is comparatively low in Figure 4a and Figure 4b relative to Figure 3a and Figure 3b.

Dealers being long AIR S&P 500 Total Return (EFFR) futures and short E-mini S&P 500 futures speaks to the different risk parameters for each product.  AIR TRFs are a premium product that replicate the economics of an equity index total return swap.  The AIR TRF product reinvests realized dividends, decays by daily interest and creates a transparent equity financing market that simplifies the present value calculation of an OTC equity index swap.  The valuation of Adjusted Interest Rate S&P 500 Total Return Futures is defined in Equation 1.

Comparatively, the S&P 500 (SPX) Price Return futures (i.e. E-mini S&P 500 futures) have more Greek parameter risk. In addition to equity financing, traders must manage risks associated with an expected dividend stream, expected interest rates and correlations across these parameters.  This makes it difficult to isolate equity financing risk, see Equation 2.

Figure 3a/3b and 4a/4b are different in the share of calendar spreads relative to total open interest. According to the CFTC positioning report for AIR S&P 500 Total Return (EFFR) futures highlighted in red, almost 33% of dealer positions are a calendar spread, relative to only 1.5% for E-mini S&P 500 futures. Dealer-heavy usage of AIR TRF calendar spreads unveils one of the core benefits of the product.

Utilizing the AIR TRF product for calendar spreads speaks to the market’s desire to optimize for capital usage, liquidity and risk. Carrying over-the-counter (OTC) bi-lateral derivative positions have large balance sheet implications for the marketplace and necessitates trading offsetting positions to reduce risk.  Hedging a 7 year SPX OTC call option requires offsetting 7-year equity financing exposure that can be hedged more precisely and less expensively by unlocking capital efficiencies using AIR S&P 500 Total Return (EFFR) futures. As seen in the AIR TRF Term Structure tool in Figure 5, equity financing costs have steadily been increasing across the curve with the market hitting repeated daily all-time highs. Section 5 will look at a simple calendar spread example.

Understanding the calendar spreads economics starts with knowing the difference between the financing spreads. When you trade an AIR TRF calendar spread, the SPTR performance and accrued financing (AF) from Equation 1 net out; see Figure 6.

Trading a calendar spread is equivalent to trading the spread between the Financing Spread Adjustment (FSA) of two or more contracts. Because FSA is path dependent for each contract, historic data (sourced from DataMine) is used to attribute changes in the FSA term with daily financing spread paid, spread risk, equity risk and cross risk. The referenced whitepaper defines the daily profit and loss explanation for each of these risks.  

Although FSA can be volatile like delta, the impact on the future valuation is small given the relative size of the FSA to the index price. This is analogous to the present value (PV) valuation of an equity swap. The material valuation changes come from the return of the underlying asset; however, added value is extracted from optimizing financing costs and balance sheet usage.

June 2024 quarter end experienced an increased cost of financing (richening) for the AIR S&P 500 Total Return (EFFR) Dec 31 and Dec 24 financing spreads. Figure 7 represents the Dec 24 financing spread as a dark blue line, Dec 31 financing spread with a green line and the financing premium between the contracts as a light blue line. It is notable how the term premium between Dec 31 and Dec 24 falls; i.e., as the financing richens, the curve flattens.

Table 1 displays details of a fictitious AIR S&P 500 Total Return (EFFR) calendar spread executed March 28, 2024, and unwound on June 28, 2024. As AIR TRFs trade as a basis trade at index close (BTIC), settlement prices are used for the index price, financing spreads, term premium between the contracts, the FSAs and the futures prices.

^{Source CME Group}

Although this spread widens, the buyer makes money because of the duration of the long Dec 31 contract relative to the short Dec 24 contract. The $3,316 P&L of being long one Dec 31 contract and short one Dec 24 for the quarter is the difference of the futures prices or FSAs over the period times the multiplier: i.e., from above, using futures prices: 25 * (10,706.31 - 11,343.79 + 11,804.42 - 11,034.30) or using FSA: 25 * (42.54 - 51.46 + 812.66 - 688.94)).

Table 2 displays an FSA P&L attribution over the period. In this example, the largest contributions for this trade over the period come from the spread risk and equity risk.

^{Source CME Group}

In Figure 8, we compare the AIR S&P 500 Total Return (EFFR) Dec 31 / Dec 24 calendar spread rolling three month return profile (dark blue line) to the rolling three month SPTR index returns (light blue line). This provides a visualization of the historical equity risk contribution to FSA. Figure 8 shows historically delta risk has tended to be positively correlated to FSA but not always.

Lastly, while history does not necessarily repeat itself, understanding historical FSA contributions from daily financing spread, spread risk, equity risk and cross risk can assist in the risk management process. It is interesting to know that spread risk tends to represent the largest portion of FSA contribution followed by equity risk; however, this again varies with the selected time period.

^{Source CME Group}

• Adjusted Interest Rate Total Return futures (AIR TRFs) are a capital-efficient risk management tool as both an OTC swap replacement and equity financing hedge.

• CME CORE is useful in observing portfolio margin costs and offsets.

• The AIR TRF futures product design enables isolating financing risk by trading a simple calendar spread.  This has driven much of the product volume growth.

• Trading an AIR calendar spread can be thought of as spread trading FSAs. Calculating FSA changes can be bucketed into daily financing spread paid, spread risk, equity risk and cross risk. 

• Equity financing spreads tend to mean revert, so relative value curve trading can lead to a predictable payout as long as the variables of time and drawdowns can be managed.