The Cash-Futures Basis Trade

Buy a Treasury bond, sell a Treasury future against it, and hold until delivery. If done with the cheapest-to-deliver bond, this position is close to riskless on the interest-rate move itself — both legs track the same bond — and what's left over is a small, fairly stable gap between the bond's cash price and what the future implies it should be worth. Capturing that gap, repeatably and in large size using borrowed money, is the cash-futures basis trade, one of the most heavily used strategies by relative-value hedge funds.

Where the profit actually comes from

$$\text{Basis} = \text{Bond price} - (\text{Futures price} \times \text{CF})$$

In words: how much more (or less) the cash bond costs than the futures market implies it should. A positive basis means the bond is rich relative to the future, or equivalently the future is cheap relative to the bond — that gap should shrink as delivery approaches, since at expiry the two must converge for the CTD bond. Along the way, the trade also earns (or pays) carry: the bond's coupon income minus the cost of financing the position in repo.

Worked example

A fund buys $100 million face of the CTD bond at a basis of 12 ticks, where each tick is 1/32nd of a point. One thirty-second of a point on $100 million face is worth $31,250, so 12 ticks of basis is worth:

$$12 \times 31{,}250 = 375{,}000$$

That $375,000 is the value of the basis position on $100 million notional. The position is financed entirely in repo — the fund puts up only the repo haircut in cash, often 1-2%, leveraging a small equity base many times over. If the basis narrows to 4 ticks by delivery, the fund captures roughly 8 ticks of convergence on the full $100 million notional, a substantial return on the sliver of actual cash posted.

What this means in practice

Because the trade is financed with very little equity, it delivers a small, steady return on a large notional — attractive precisely because it's normally low-volatility. That's also its danger: when repo funding suddenly gets expensive or unavailable (as happened in March 2020), highly leveraged basis positions can be forced to unwind all at once, and the very act of unwinding widens the basis further, amplifying losses exactly when financing is hardest to find.