How Do You Short Treasuries

Intrigued by the potential for profiting from a rise in interest rates or a decline in bond prices? Shorting US Treasuries offers a way to do just that. However, it's important to understand the different strategies available and the risks involved before diving in. This article explores various methods for shorting Treasuries, from easily accessible Exchange Traded Funds (ETFs) to more complex derivative instruments.

Ways to Short US Treasuries

There are a few ways to short treasuries:

1. Use inverse or short Treasury ETFs. These ETFs are designed to move in the opposite direction of Treasury prices. Some examples include:
   1. ProShares Short 7-10 Year Treasury (TBX) which seeks daily investment results that correspond to the inverse (-1x) of the daily performance of the ICE U.S. Treasury 7-10 Year Bond Index
   2. ProShares UltraShort Barclays 7-10 Year Treasury (PST) which seeks daily investment results that correspond to twice (200%) the inverse of the daily performance of the Barclays Capital 7-10 Year U.S. Treasury Index
2. Sell Treasury futures contracts. Selling Treasury futures allows you to profit if Treasury prices decline. However, this strategy requires a futures trading account and involves leverage, so it is riskier.
3. Buy put options on Treasury ETFs or futures. Purchasing put options gives you the right to sell Treasuries at a set price in the future. If Treasury prices fall, the put options will increase in value.
4. Sell Treasury bonds short. You can borrow Treasury bonds and sell them, hoping to buy them back at a lower price to return to the lender. However, this is difficult for individual investors to execute.

The easiest and most accessible way for individual investors to short Treasuries is through inverse or short Treasury ETFs, which can be bought and sold like stocks in a regular brokerage account. However, these ETFs are designed for short-term trading and can lose value over time even if Treasury prices decline, so they require careful monitoring.

What Are the Risks of Shorting Treasuries

There are several key risks associated with shorting Treasuries:

1. Margin calls and forced selling: Hedge funds have amassed a large $600-800 billion net short position in Treasury futures, often using borrowed money and leverage. If margin requirements increase, they may be forced to post more collateral or unwind their positions by selling Treasuries. This could trigger a damaging sell-off in the Treasury market similar to the "dash for cash" in March 2020.
2. Disruption to the Treasury market: A sudden unwinding of these large short positions could disrupt the $25 trillion Treasury market and cause yields to spike. The Bank of International Settlements (BIS) has warned that this could happen if an unexpected event like a U.S. government shutdown occurs.
3. Losses from rising Treasury prices: The risk of short selling is that Treasury prices could appreciate, forcing short sellers to buy back the bonds at a higher price and realize losses. Treasuries are considered a safe haven asset, so their prices tend to rise in times of market stress.
4. Borrowing costs: There are costs associated with shorting Treasuries, including the coupon payments that accrue while the bond is shorted and fees charged by brokers to lend the bonds. These costs can eat into potential profits.
5. Lack of liquidity: Shorting Treasuries can be difficult if the bonds are scarce or in high demand from other short sellers. This can make it hard to borrow the bonds and increase the costs.

What Is the Repo Market and How Does It Relate To Shorting Treasuries

The repo market, short for repurchase agreement market, is a crucial component of the financial system where banks, financial institutions, and sometimes even individuals engage in short-term borrowing and lending using securities as collateral. In a repo transaction, one party sells securities to another party with an agreement to repurchase them at a later date, usually overnight or within a few days, at a slightly higher price. Essentially, it's a short-term collateralized loan.

Now, how does this relate to shorting treasuries? Shorting treasuries involves borrowing and selling government bonds with the expectation that their price will fall, allowing the investor to buy them back at a lower price and profit from the difference. In this process, the investor needs to borrow the treasuries they intend to sell short. This borrowing often occurs in the repo market.

Here's how it typically works: A trader who wants to short treasuries will borrow them through a repo transaction, using the treasuries themselves as collateral. They then sell these borrowed treasuries on the open market. Later, when they're ready to close out their short position, they repurchase the treasuries and return them to the lender, completing the repo transaction.

So, the repo market provides the mechanism for short sellers to borrow the securities they want to short, including treasuries, facilitating their ability to execute short positions in the market.