How to Profit From Front-Running the Government Bond Auctions
Interest-Rates / US Bonds Jun 15, 2009 - 03:13 PM GMTBy: DailyWealth
Tom Dyson writes:
Front-running is illegal.
Here's how it works: A crooked broker receives a large order from a customer. Before he executes the customer's order, he'll buy the stock in his own account. The customer's order pushes the price of the stock up and gives him an easy profit.
Today, I'm going to show you how to "front-run" the U.S. government. This trade is not illegal. The information we'll use is public, not "inside" information. But the profits are just as easy... As I showed you in an essay last week, the Treasury sells around $165 billion bonds each month to pay for the government's spending plans. It auctions these bonds on Tuesdays, Wednesdays, and Thursdays in the second and fourth weeks of the month. In that essay, I showed you how to trade these auctions each month. Today, I've got a slightly different twist, which I think will end up being more profitable...
To make money, all you have to do is front-run the Treasury's sales of bonds. In other words, you sell short bonds just before the auctions begin on Tuesday, and then cover your short after the last auction on Thursday. Repeat every two weeks.
Normally, strategies like this don't work in the financial markets. Traders mark down prices in advance of the auctions, so there's no benefit to front-runners. But in this case, my guess is, the Treasury's auctions are so large, they are bludgeoning the market lower, despite the traders' moves.
Take the most recent "front-running" trade as an example. Between Tuesday, June 9, and Thursday, June 11, the Treasury auctioned $65 billion in three-year, 10-year, and 30-year bonds.
The UltraShort 20+ Year Treasury ProShares (TBT) is the ETF that rises when bonds fall in price. It opened at $56.58 on the morning of the first auction and closed at $57.72 the evening of the last auction. Government front-runners made 2% in three days.
You could have put on this trade 12 times in the past six months, and you would have profited eight times... with an average gain of 1.8% per trade and an average three-day holding period.
Front-Running the Government |
Average Gain |
1.8% | ||||
| Buy TBT at the open price on Tuesday and sell at the closing price on Thursday, auction weeks only. | |||||
It may not sound like much, but compounding your money at 1.8% every two weeks turns every $1,000 you invest into $1,530 in one year. That's a 50% gain with just a handful of tiny trades. And with leverage, the gains would be even greater.
This week, there are no Treasury auctions... and TBT is falling. The next auctions are next week, starting Tuesday. To front-run the government, buy TBT first thing on Tuesday morning June 23 and then cover your position late on Thursday evening. Repeat every two weeks.
Good investing,
Tom
P.S. Click here for a link to the schedule of government bond auctions.
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