Introduction

A feedback control process in trading is an integral, if not the most important, part of risk management in trading. Traders should identify and monitor the sources and risks of the trading returns in real time. This almost instant feedback provides the invaluable “dash board” control, tightly linking the trader’s actions to the trading profitability.

There are three major sources of Treasuries and Treasury futures returns over a relatively short time interval, say 10 minutes. They are:

·         Yield curve returns: the Treasury (cash and futures) positions affected by twists and turns of the yield curve

·         Cheap/Rich changes: the cheap/rich value is defined as the market price net of the model price. Stochastic non-synchronized buy and sell orders may lead to over- or under- pricing of the securities. The change of the cheap/rich values would lead to returns of the portfolio.

·         Non-yield curve returns: there are other factors affecting the returns of the securities or derivatives beyond the yield curve movements. They are: returns due to buys and sells from the account, change in the market volatilities for example.

An Example

Let us consider a calendar trade of holding a September contract and selling a December 5 year contracts, $100,000 notional amount for each contract.

A.