What Are Off‑The‑Run Treasuries?
Key takeaways
– Off‑the‑run Treasuries are previously issued U.S. Treasury notes or bonds that have been superseded by the most recently issued (on‑the‑run) security of the same maturity.
– They trade only in the secondary market and are generally less liquid than on‑the‑run issues, which typically makes them slightly cheaper and yields modestly higher.
– Market participants use off‑the‑run yields for yield‑curve construction and relative‑value trades to avoid distortions caused by the sometimes elevated demand for on‑the‑run issues.
– Retail investors can buy off‑the‑run Treasuries through brokers or via funds; institutional traders use them for hedging, arbitrage, and yield‑curve modeling.
Source: Investopedia (https://www.investopedia.com/terms/o/off-the-runtreasuries.asp)
1. What “on‑the‑run” vs “off‑the‑run” means
– On‑the‑run: the most recently auctioned Treasury security of a given maturity (e.g., the current 5‑year note). These are the most liquid Treasury issues and are often used as market reference points.
– Off‑the‑run: previous issues with the same maturity that are no longer the newest issue. Once a new security of that tenor is auctioned, the prior issue becomes off‑the‑run.
2. How a Treasury moves from on‑the‑run to off‑the‑run
– The U.S. Treasury issues notes and bonds via auction.
– The auctioned instrument becomes the on‑the‑run instrument.
– When a subsequent auction releases a newer security of the same maturity, the previous one becomes off‑the‑run and trades primarily in the secondary OTC market.
3. Why off‑the‑run yields are generally higher
– Liquidity premium: On‑the‑run securities attract more trading, so investors accept lower yields for greater liquidity. Off‑the‑run issues trade less frequently, so investors demand a slight premium (higher yield).
– Limited supply/strong demand: Fixed issuance of on‑the‑run plus high demand pushes on‑the‑run prices up and yields down relative to off‑the‑run.
– Hold‑to‑maturity behavior: Off‑the‑run securities are often bought and held, reducing turnover and liquidity compared with on‑the‑run.
– Result: a persistent yield spread (often measured in basis points) between on‑ and off‑the‑run securities.
4. Where to trade off‑the‑run Treasuries
– Retail investors:
– Full‑service or online brokers (buy/sell secondary Treasuries).
– Treasury ETFs or mutual funds (e.g., funds that hold a mix of on‑ and off‑the‑run securities).
– Note: TreasuryDirect generally only sells new issues (on‑the‑run); it does not sell off‑the‑run securities.
– Institutional traders:
– Interdealer brokers and platforms (Bloomberg, Tradeweb) and electronic platforms for larger OTC trades.
– Repo markets and bilateral trades for financing.
– Price quotes and data:
– Market data providers (Bloomberg, Refinitiv), broker quotes, or the dealer network.
5. How market participants use off‑the‑run Treasuries
– Yield‑curve construction: Using off‑the‑run yields can reduce distortions caused by temporary demand spikes for on‑the‑run issues. Analysts may interpolate a smooth curve from off‑the‑run data.
– Relative‑value/arbitrage trades: Traders exploit the on/off spread (e.g., sell on‑the‑run and buy comparable off‑the‑run if they expect the spread to compress).
– Hedging and portfolio positioning: Institutions use off‑the‑run bonds to fine‑tune duration and cash‑flow matching at often more attractive yields.
– Carry trades: Buy higher‑yielding off‑the‑run while financing cheaply in the repo market—subject to liquidity and financing risk.
6. Practical steps — retail investor (buying off‑the‑run Treasuries)
1) Define objective: income, laddering, duration, or trade.
2) Check available channels: your broker’s Treasury desk, bond screener, or fixed‑income section.
3) Identify candidate securities: match maturity and coupon you want; compare on‑ vs off‑the‑run prices and yields.
4) Compare yields and costs: account for bid‑ask spreads and any commission. Off‑the‑run can have wider spreads.
5) Execute trade: place an order through your broker; for best execution consider limit orders to control price.
6) Manage position: monitor liquidity (harder to sell quickly), consider hold‑to‑maturity if illiquidity is a concern, or use ETFs for easier liquidity if desired.
Practical steps — institutional trader or analyst
1) Data gathering: pull on‑ and off‑the‑run prices/yields from Bloomberg/Tradeweb or dealer quotes.
2) Calculate spread: Spread (bps) = (Yield_off − Yield_on) × 10000. Example: if on‑the‑run = 1.50% and off‑the‑run = 1.60%, spread = 10 bps.
3) Decide strategy: yield‑curve fitting, relative‑value trade, basis trade, or hedging.
4) Size & funding: determine position size, financing source (repo or cash), and margin requirements.
5) Execute and monitor: use electronic platforms or dealer brokers; monitor spread, liquidity and funding cost; be ready to unwind if liquidity dries up.
6) Risk controls: set stop losses, liquidity limits, and stress scenarios (e.g., repo rates spike).
7. Example: calculating an on/off spread
– Given:
– On‑the‑run 5‑year note yield = 1.50%
– Off‑the‑run 5‑year note yield = 1.62%
– Spread = 1.62% − 1.50% = 0.12% = 12 basis points (bps)
– Interpretation: You would earn 12 bps more annually by holding the off‑the‑run note, but expect wider transaction costs and lower liquidity.
8. Using off‑the‑run yields to build a yield curve (practical outline)
1) Collect prices and yields across different maturities, prioritizing off‑the‑run issues to avoid on‑the‑run demand distortions.
2) Convert coupon prices to zero rates by stripping cash flows or use bootstrapping to derive spot rates.
3) Interpolate between maturities to create a continuous curve (linear, spline, or cubic smoothing—choose based on desired smoothness).
4) Validate: compare to market swap curve, on‑the‑run curve, and check for arbitrage opportunities or mispricings.
5) Recalibrate regularly, as off‑the‑run liquidity and dealer inventories change.
9. Risks and considerations
– Liquidity risk: off‑the‑run issues often have wider bid‑ask spreads and may be hard to sell in stressed markets.
– Execution costs: higher transaction costs can offset yield pickup.
– Market risk: interest rate moves affect prices regardless of on/off status.
– Funding risk: if you finance the purchase in the repo market, repo rate spikes can erode carry.
– Model risk: yield‑curve construction choices (interpolation methods) affect derived values.
– Counterparty risk: in bilateral trades or repo financing, consider the counterparty’s creditworthiness.
10. Alternatives for gaining exposure
– Treasury ETFs and mutual funds (liquid, diversified exposure to Treasury market including off‑the‑run holdings).
– Laddered portfolios of newly issued Treasuries via TreasuryDirect (on‑the‑run) or brokers.
– Futures and swaps for duration exposure (liquid but involve derivatives risk).
11. Summary
Off‑the‑run Treasuries are past issues of a given maturity that trade chiefly in the secondary market. They typically offer slightly higher yields as compensation for lower liquidity and tighter market demand compared with on‑the‑run issues. Market participants use off‑the‑run yields for yield‑curve construction, relative‑value trading, and efficient portfolio fitting. Retail investors can acquire off‑the‑run Treasuries through brokers or funds, but should weigh the yield pickup against greater transaction costs and liquidity risk.
Primary source
– Investopedia — “Off‑The‑Run Treasuries”: https://www.investopedia.com/terms/o/off-the-runtreasuries.asp
Additional reference
– TreasuryDirect (U.S. Treasury information on buying new issues): https://www.treasurydirect.gov
If you want, I can:
– Show a worked numeric example of bootstrapping a simple yield curve from off‑the‑run prices.
– Compare a sample on‑the‑run vs off‑the‑run yield series for a recent date (requires market data).