What is basis trading in T-note futures and how do traders profit from it?

Question

AcadiFi · Accepted Answer

Basis trading exploits the difference between the spot price of a deliverable Treasury note and its futures-implied price (futures price multiplied by the conversion factor). A trader like Arcadian Yield Partners buys a 6.5% coupon T-note at 108-16, sells the corresponding 10-year futures at 118-08 with CF of 0.9012, giving an implied invoice of 118.25 * 0.9012 = 106.59. The raw basis is 108.50 - 106.59 = 1.91. The trader earns carry (coupon minus repo) while holding the position, plus any favorable convergence as delivery nears. The risk lies in repo spikes and changes in the cheapest-to-deliver bond. During 2020, repo stress blew out basis trades because leveraged positions (often 50x) forced unwinds. The profit equation is: P/L = carry earned + (basis change). Basis narrows as delivery approaches if the bond remains CTD, so patient traders collect carry and pocket convergence.

```mermaid
flowchart TD
  Buy[Buy Cash Bond] --> Short[Short Futures]
  Short --> Repo[Finance via Repo]
  Repo --> Carry[Earn Coupon vs Repo]
  Carry --> Deliver{Hold to Delivery?}
  Deliver -->|Yes| Conv[Capture Convergence]
  Deliver -->|No| Unwind[Unwind at Market]
```

What is basis trading in T-note futures and how do traders profit from it?

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