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NFX Basis Point Value Contracts; One quarter hubris, three quarters details

John Lothian

John Lothian

Executive Chairman

The hubris is mine, not Nasdaq’s. Over 20 years ago I came up with the idea for an innovative new futures contract that would improve hedging and engage speculators in new ways in fixed income trading. The idea was basis point value futures.

Today, Nasdaq announced just that: a new U.S. Treasury futures product that builds on their cash Treasury market and allows customers to use “the dollar value of one basis point” to more accurately hedge a portfolio of cash Treasurys. The proper name of the contracts is: U.S. DV01 TREASURY FUTURES.

I have shared this idea with many people over the years, always with a disclaimer that it would take some people at a higher pay grade or education level to make it work. And so the braintrust at Nasdaq did the hard work of talking to clients, regulators and brokers and is giving it a try.

Back in 1996, I had a client who came to then futures broker John Lothian at Gerald Commodities to hedge his large and diverse Treasury portfolio. I went over to the CBOT research department and talked to Joe Benning about how to hedge this portfolio with widely diverging maturities.

Joe taught me how to determine the basis point value of an instrument, which allowed me to get the total basis point value of the portfolio. However, from there it gets a little difficult because the Treasury futures have unique basis point values tied to the cheapest to deliver, not the collection of off-the-run stuff in this portfolio.

In the end we were able to get hedged to about 90 percent. Thus, the idea of basis point value futures came to me as a way to hedge the client’s risks more precisely. The idea I had was for a small contract that would allow hedging of more specific basis point value risk.

However, Nasdaq has chosen to create a large $1 million contract to match the minimum trade size on the Nasdaq Fixed Income, formerly eSpeed, cash Treasury platform. The futures contract will traded on NFX, Nasdaq Futures Exchange, Inc.

They are starting with the on-the-run U.S. Treasury 10-year notes on Thursday, July 19, 2018, pending regulatory approval.

The contracts will be cleared by The Options Clearing Corporation. The daily settlement will use a “quality weighted average price,” or QWAP, of the best bids, offers and executed transactions. The final settlement will use the same QWAP process during the settlement period described by each product rule.

This new entry to the Treasury futures marketplace is not meant as a response to the CME Group’s purchase of NEX, as the research and development for DV01 futures was done long before Nasdaq became aware of that deal. It is a good response nonetheless.

This is a way for Nasdaq to enter the Treasury futures business with an innovative and needed contract. It does not directly challenge the giant incumbent in Treasury futures, the CME Group, rather it complements them. This is a product that can be used alongside the deep and liquid products at the CME Group.

This is the type of contract I have long been in favor of – complementary, innovative and potentially disruptive long-term. I even put this idea in writing and posted it to the website John Lothian News launched after the MF Global and PFG implosions in order to generate new ideas for the industry.

Nasdaq says they came up with the idea based on discussions with clients and internal product specialists, including Ted Bragg, vice president and head of US fixed income at Nasdaq. So we may or may not ever know if my idea seeped into this new contract in some way. It does not matter, as the ideas behind the contract can’t be patented.

This is not the only contract idea I have shared with people, but it is the first one to potentially see the light of day.  It will be exciting to watch!

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