How to Short U.S. Treasury Bonds

Go Long Strength and Short Weakness

U.S. Treasury bonds are the most liquid and marketable securities traded in the United States and they vary in price depending on interest rate expectations. Bond professionals who believe interest rates are going higher ( bond prices go lower) see a profit opportunity by borrowing an institution's bond holdings for a fee, and selling the bonds into the marketplace. If interest rates do rise bond professionals buy the same bonds back and return them to the institution. The bond trader keeps the difference in price, the institution makes a fee greater than just holding the bonds. The loser is the party who held the bonds during the price decline. Shorting is just the opposite of buying in expectation of lower yields. The intermediate step of borrowing or hypothecation is merely a technical problem that large portfolio and trading institutions deal with regularly.

Things You'll Need

• Internet access
• Bond calculator with accrued interest function

Instructions

Reasons to Short Treasuries

1. Shorting a bond means that you believe the principal price of the bond will decline. When shorting a bond you are responsible for the interest that accrues everyday the bond is not delivered to the customer you sold the bond to. Bonds can usually be borrowed for a margin deposit but you will still be responsible for all the government interest.that accrues to the real holder of the bond.

2. Short U. S. Treasuries in order to make a bet that interest rates are going higher. Make certain that the maturity you are shorting is the most likely to decline. Fed tightening will raise short rates but result in lower rates in the intermediate and long end as the economy slows as a result of tightening. Rising inflation leads to higher rates in order to offset compensate for principal depreciation. Use your broker to guide your program and find specific maturities to short.

3. Short only treasuries where there is an ample supply of bonds available. You must cover (buy back) the exact same maturity and coupon that you shorted. It is a good idea to short preceding the government auction for a bond because the bond does not settle for a few days after the auction. This means that no accrued interest cost begins until the settlement date. This is called 'trading on a when issued basis.'

4. Open a futures account and short the government 10 year treasury bond contract. There is no accrued interest to be paid. Margin on bond futures is less than 10 percent of market value. In addition, there will be no need to cover the account short with a specific bond. Simply buy back the contract in the open futures market.

5. Short the relationship of the different maturities in the yield curve by buying what you think will be the best performing maturity and shorting the expected weaker maturity. The interest on the long maturity will help offset or even exceed the interest on the short maturity and you will still profit if the short strategy is correct. For small investors shorting securities in less than $100,000 amounts is not cost effective due to commissions.

Tips & Warnings

• Shorting U.S. Treasury bonds is purely an interest rate play. Short low rated corporate bonds for trades involving expected credit deterioration.

• Because of the trading size needed to short treasury bonds consider using the cheaper and more efficient futures market.

Resources

• Source for Quotes of All Government Bonds
• Bond Calculator with Accrued Interest Function