Using Futures and Swaps to Adjust Duration

Duration adjustment without selling bonds is the mark of an efficient fixed income manager. Futures overlays and interest rate swaps let you change portfolio sensitivity to rates in hours rather than weeks—without triggering capital gains, disrupting yield, or paying dealer spreads on physical bonds. The point is: derivatives don't replace your portfolio; they modify its behavior while leaving the underlying assets intact.

Why Derivatives Beat Cash Market Adjustments (When They Do)

Selling bonds to shorten duration forces you to realize gains or losses, pay transaction costs, and potentially sacrifice higher-yielding positions. A $25 million portfolio manager wanting to cut duration from 6.1 years to 4.0 years would need to sell approximately $8-10 million in long bonds and reinvest in shorter maturities.

The alternative: Sell Treasury futures contracts worth an equivalent DV01 reduction. No bond sales, no tax events, minimal transaction costs (futures commissions run $1-2 per contract versus 0.25-0.50% dealer spreads on corporate bonds).

A clear trade-off exists. Futures overlays require margin management, roll costs every quarter, and basis risk between your portfolio and the cheapest-to-deliver Treasury. Swaps require counterparty documentation and credit support annexes. Neither approach is free—but both cost less than restructuring a bond portfolio.

Treasury Futures: The Workhorse of Duration Overlays

Treasury futures trade on CME in four key maturities: 2-year, 5-year, 10-year, and 30-year (with an Ultra 10-year and Ultra 30-year for longer duration). Each contract represents $100,000 face value of a deliverable Treasury security.

DV01 values differ dramatically across the curve:

Source: CME Group (2024). The 30-year bond moves 5.6x more per basis point than the 2-year note—which is precisely why you use them for different objectives.

The durable lesson: matching DV01 (dollar exposure per basis point) rather than notional value is what creates an effective hedge.

Worked Example: Cutting Duration with Futures

You manage a $25 million corporate bond portfolio with 6.1-year modified duration. Your CIO wants exposure reduced to 4.0 years ahead of a Fed meeting. Selling bonds would take two weeks and trigger significant realized gains.

Step 1: Calculate Current and Target DV01

Current portfolio DV01: $$DV01_{portfolio} = Duration \times MarketValue \times 0.0001$$ $$DV01_{portfolio} = 6.1 \times $25,000,000 \times 0.0001 = $15,250$$

Your portfolio gains or loses $15,250 for every 1 bp move in yields.

Target DV01: $$DV01_{target} = 4.0 \times $25,000,000 \times 0.0001 = $10,000$$

You need to reduce DV01 by $5,250 ($15,250 - $10,000).

Step 2: Select Futures Contract and Calculate Hedge Ratio

Using 10-year Treasury Note futures (DV01 approximately $85 per contract):

Contracts to sell: $$Contracts = \frac{DV01_{reduction}}{DV01_{futures}} = \frac{$5,250}{$85} = 62 contracts$$

Sell 62 ten-year Treasury Note futures.

Step 3: Verify New Effective Duration

Hedge DV01: 62 contracts x $85 = $5,270 (short position, reducing exposure)

Net portfolio DV01: $15,250 - $5,270 = $9,980

New effective duration: $$Duration_{effective} = \frac{$9,980}{$25,000,000 \times 0.0001} = 3.99 years$$

Duration now rounds to 4.0 years as targeted.

The Cheapest-to-Deliver (CTD) Complication

Treasury futures don't settle into a single bond—they allow delivery of any Treasury within a maturity range. The cheapest-to-deliver bond determines the futures contract's actual duration and DV01.

Why this matters: The CTD changes when rates move significantly. In a rising rate environment, higher-coupon bonds with shorter duration often become CTD. Your hedge ratio calculated at 5% yields may drift if yields move to 6%.

The fix: Monitor CTD duration and adjust hedge ratios monthly or when rates move 50+ bps. Some managers use conversion factors to normalize, but the cleanest approach is recalculating based on current CTD characteristics.

Interest Rate Swaps: When Futures Don't Fit

Swaps offer two advantages over futures: customizable maturities (you're not stuck with 2, 5, 10, or 30 years) and no roll costs (swaps can match your exact horizon without quarterly rollovers).

A vanilla interest rate swap structure:

• You receive fixed and pay floating to shorten duration
• You pay fixed and receive floating to extend duration

The notional amount determines how much duration you add or remove. A 5-year swap with $10 million notional has approximately the same duration impact as $10 million in 5-year bonds.

The DV01 of a swap: A receiving-fixed swap has positive DV01 (benefits from rate declines). A paying-fixed swap has negative DV01 (benefits from rate increases). Match swap DV01 to your desired duration change just as with futures.

Worked Example: Extending Duration with a Swap

Your liability-driven portfolio has $50 million in assets with 4.5-year duration. A new pension obligation requires matching 7.0-year duration. Buying long bonds would overweight your credit allocation.

Step 1: Calculate Required Duration Extension

Duration gap: 7.0 - 4.5 = 2.5 years

Additional DV01 needed: $$DV01_{gap} = 2.5 \times $50,000,000 \times 0.0001 = $12,500$$

Step 2: Structure the Swap

A 10-year receive-fixed swap has duration of approximately 7.5 years (roughly the average maturity of fixed payments).

Swap notional to achieve target: $$Notional = \frac{DV01_{needed}}{SwapDuration \times 0.0001} = \frac{$12,500}{7.5 \times 0.0001} = $16,666,667$$

Enter a $16.7 million notional 10-year swap, receiving fixed rate, paying SOFR floating.

Step 3: Verify New Portfolio Duration

Swap DV01: 7.5 x $16,666,667 x 0.0001 = $12,500

Combined DV01: $22,500 (original) + $12,500 (swap) = $35,000

Effective duration: $35,000 / ($50,000,000 x 0.0001) = 7.0 years

Mission accomplished—without buying a single bond.

Key Rate Duration Adjustments (Surgical Precision)

Overall portfolio duration tells you parallel-shift exposure. But yield curves twist, steepen, and flatten. Key rate duration at specific maturity points (2-year, 5-year, 10-year, 30-year) lets you hedge curve risk surgically.

Example scenario: Your portfolio has too much 10-year exposure relative to 2-year. A steepener trade would hurt you.

CME Group (2020) case study: A portfolio manager sold 1,251 contracts at a specific maturity point to reduce key rate duration, leaving other points unchanged. Using the 10-year futures (DV01 $85) to reduce 10-year key rate exposure by $106,335 requires 1,251 contracts ($106,335 / $85).

The test: A steepener hurts you if:

• Your 10-year key rate duration exceeds your 2-year key rate duration
• Your curve exposure is long the belly, short the wings
• Your barbell position is underweight versus bullet benchmarks

Curve Trades with Futures: Steepeners and Flatteners

Beyond duration adjustment, futures enable explicit curve views:

Steepener trade: Buy short-term futures, sell long-term futures. Profits if the 2s-10s spread widens.

DV01-neutral ratio: To be neutral on parallel shifts while expressing a curve view, match DV01 on both legs. Given 2-year DV01 of $38 and 10-year DV01 of $85, you'd buy approximately 2.2 contracts of 2-year notes for every 1 contract of 10-year notes sold.

CME Group (2024) provides the exact ratio: 19 two-year contracts versus 10 ten-year contracts for a DV01-neutral steepener.

Flattener trade: Reverse the positions—sell short-term futures, buy long-term futures. Profits when the spread narrows.

The 2022-2024 yield curve inversion (2y-10y spread reaching -100 bps) rewarded flatteners massively before reversing in late 2024 (Federal Reserve, 2024).

Detection Signals: You're Likely Misusing Overlays If...

• Your futures position DV01 exceeds your cash portfolio DV01 (you're speculating, not hedging)
• You haven't adjusted hedge ratios in 60+ days despite rate moves of 50+ bps
• Your roll costs exceed 15 bps annually without active management
• Your swap counterparty margin calls surprise you (credit support annex wasn't modeled)
• You extended duration with 30-year futures when a 10-year swap would have matched liability exactly

Checklist: Implementing a Duration Overlay

Essential (Start Here)

• Calculate current portfolio DV01 and target DV01
• Choose instrument: futures for standard maturities, swaps for custom horizons
• Size position using DV01 ratio (contracts = DV01 gap / contract DV01)
• Verify post-hedge duration matches target within 0.1 years

High-Impact Refinements

• Monitor CTD duration changes for futures hedges
• Set rebalancing triggers: 50 bps rate move or 0.25 year duration drift
• Model roll costs (futures) or credit spread on swap rate (swaps)

Common Mistakes and How to Avoid Them

Mistake 1: Using notional value instead of DV01 for hedge sizing

A $10 million notional in 2-year futures has completely different rate exposure than $10 million in 30-year futures. Always match DV01, not dollars.

Mistake 2: Ignoring basis risk between portfolio and hedge instrument

Corporate bonds don't move identically to Treasury futures. During the March 2020 COVID crisis, investment-grade spreads widened 200+ bps while Treasury futures rallied—your hedge could work against you if the correlation breaks.

Mistake 3: Forgetting quarterly roll costs on futures

Rolling four times a year with 3-5 bps roll cost per quarter adds 12-20 bps annually. For a 5-year holding period, that's 60-100 bps in cumulative drag versus an equivalent swap with no roll.

Your Next Step

Review your current bond portfolio's duration and identify whether it matches your rate view or liability profile. Calculate the DV01 adjustment needed and price out both a futures overlay (using CME contract specifications) and a plain vanilla swap. Compare execution costs, margin requirements, and ongoing management burden before choosing.

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Related: Dollar Duration and DV01 Basics | Duration Matching for Liability Immunization | Key Rate Duration to Measure Curve Risk

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Sources: CME Group (2024). Trading the Treasury Yield Curve. | CME Group (2020). Key Rate Duration Adjustment Case Study. | CFA Institute (2026). Liability-Driven and Index-Based Strategies. | Federal Reserve Board (2025). Nominal Yield Curve Methodology.