The municipal-treasury futures spread

✍ Scribed by Marcelle Arak; Raj Daryanani; Philip Fischer; Laurie Goodman

• Book ID: 102843907
• Publisher: John Wiley and Sons
• Year: 1987
• Tongue: English
• Weight: 852 KB
• Volume: 7
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990070402

✦ Synopsis

ith the debut of the municipal bond index futures contract in June of 1985, W market participants began keeping a watchful eye on the municipal-Treasury futures spread. This spread has varied widely, ranging from a low of negative eight points up to a high of plus 10% points. This has led market participants to question whether or not muni futures are being priced appropriately relative to Treasury futures.

If, in fact, one market is mispriced relative to another, one can often profit from the situation by purchasing the underpriced security and shorting the other. It is particularly easy to utilize such opportunities in the futures markets. Transactions costs for futures trades are very low-ranging from $12 to $25 per contract. By contrast, arbitrage that involves the use of the cash market can be expensive for nondealers, particularly if it involves shorting a security; it is difficult to short municipal bonds, even for dealer firms. Thus the municipal-Treasury futures spread can help keep municipal futures closer to their theoretical level.

In this article, after presenting a brief overview of the municipal futures contract, we develop a model of the theoretical range for the muni futures-Treasury futures spread (the MOB). Comparing actual spreads with our theoretical model, we show that in its early months the municipal futures contract was mispriced, and this was reflected in the MOB spread. More recently, however, the MOB has usually traded *The authors would like to thank John M. Cheney, and two anonymous referees for their helpful comments. This article was written while all authors were affiliated with Citicorp Investment Bank.