What Is a Five Against Bond Spread (FAB)
A Five Against Bond Spread (FAB) is a futures trading strategy that seeks to benefit from the spread between Treasury bonds of differing maturities by taking offsetting positions in futures contracts for five-year Treasury notes and long-term (15 to 30 year) Treasury bonds.
Understanding a Five Against Bond Spread (FAB)
A Five Against Bond Spread (FAB) is created by either buying a futures contract on five-year Treasury notes and selling one on long-term Treasury bonds or vice versa. Investors speculating on interest rate fluctuations will enter into this type of spread in hopes of profiting from under or overpriced Treasuries.
Investors can trade futures contracts on 2-year, 5-year, 10-year, and 30-year Treasury securities. Unlike options, which give holders the right to buy or sell an asset, futures obligate the holder to buy or sell. These contracts are offered by the Chicago Board of Trade and are listed on March, June, September, and December cycles. Futures contracts needed to establish a FAB have face values of $100,000 with prices quoted in points per $1,000. Contracts can be traded in tick sizes as small as 1/32 of one point or $31.25 for 30-year bonds and half of a 1/32 of a point or $15.625 for 10-year notes.
While some Treasury futures strategies are intended to hedge against interest rate risk, a FAB strategy seeks to profit from rate and yield movements. FAB is one of multiple spread trading or yield curve trading strategies applicable in the Treasury market. The basic premise of these strategies is that mispricings in spreads, as reflected in futures contract prices along the Treasury yield curve, will eventually normalize or revert. Traders can profit from these movements by taking positions through futures. Spread strategies are based more on long-term moves in yields as opposed to the rapid price action that often occurs in equity markets.
Factors Influencing Five Against Bond Spread
Bond yields, and thus spreads between bonds of differing maturities, are affected by interest rates. Short-term interest rates are most influenced by the actions of the U.S. Federal Reserve as its federal fund's rate serves as benchmark for many other interest rates. When the Fed is raising rates, 2-year and 5-year Treasury yields are most impacted. Long-term bond rates are most influenced by the strength of the U.S. economy and the outlook for inflation. If the economy is growing and inflation is at 2% or higher, long bond yields are likely to decline. These and many other economic and technical factors should be considered by investors interested in implementing spread strategies.