What is a Five Against Note Spread?

A five against note spread (FAN) is a futures spread using positions in five-year treasury notes to offset positions in 10-year treasury notes.

Understanding Five Against Note Spreads (FAN)

A five against note spread (FAN) describes a strategy used in futures trading. In a futures spread trade, an investor simultaneously takes two positions of different durations. As with any paired transaction, investors expect the long leg of the trade to rise in value and the short leg to fall. The two legs of a FAN use five-year treasury notes and 10-year treasury notes.

Treasury notes are U.S. government bonds issued with maturities of 10 years or less. Under typical conditions and a normal yield curve, longer-duration bonds will yield more than shorter-duration bonds to compensate investors for interest rate risk. The price of a treasury note or bond gets decided via an auction and may wind up above or below the face value of the note depending upon supply and demand. High demand for notes can force investors to pay a premium over the face value, while low demand can result in discounted prices, below the bond’s par value.

Example of a FAN Strategy

A FAN strategy rests upon an investor’s prediction about the change in the price of five- and 10-year treasury notes over time. Specifically, investors make money if the ratio of the prices of the two legs of the trade rises. To make money off a FAN, an investor will need to make a correct prediction about future demand for five-year notes compared to 10-year notes. If the investor foresees economic conditions that would push markets toward longer-duration notes, then the 10-year notes would form the long side of the FAN. If the investor expects greater demand on shorter-term maturities, then the five-year notes make up the long leg of the trade and the 10-year notes make up the short leg. The greater the movement between the two types of bonds in the direction of the trader’s bet, the greater the return. Situations that produce a steepening yield curve, with wider differences in price between bonds of different durations, benefit this type of trade.

Bond Yields vs. Bond Prices

While bonds serve as the underlying assets in a FAN strategy, investors do not make money directly from the yield on the bond. The FAN bets on changes in the price of the bonds over time. While yields and interest rates play a role in the amount of demand for a note and therefore its price, their influence remains indirect. Investors interested in these types of strategies should take care to understand the rationale for placing such a trade at a given time.