In addition to equities and money market investments, portfolios are often comprised of other assets, such as bonds. Your portfolio can be managed easily for both fixed-income and equity market performance by combining CBOT DJIA futures with CBOT Treasury bond futures.

Continuous changes in the anticipated rate of inflation, news about company earnings, and Federal Reserve policy changes are some of the market influences that drive investors to switch from bonds to stocks or stocks to bonds. As you will see, an efficient and inexpensive method of carrying out this reallocation between stocks and bonds is to trade spreads of CBOT Treasury bond futures and CBOT DJIA futures.

Scenario: As a prudent investor, you have always balanced your portfolio between government-backed securities and the stock market. The recent performance of the market, however, has prompted you to consider enhancing your equity portfolio while diminishing your bond portfolio. In August, you have $200,000 invested in stocks comparable to DJIA stocks and $200,000 invested in Treasury bonds. You would like to take advantage of the sustained market rally by increasing your equities exposure to 75% and decreasing your bond holdings to 25%.

Strategy: You can reallocate both sides of your portfolio - buying $100,000 of stocks and selling $100,000 of bonds - with the sale of CBOT Treasury bond September futures and the purchase of CBOT DJIA futures.

Inputs: The Treasury bonds in your portfolio have a market price of 102-04 (bond prices are quoted in 32nds; the price is 102.125). The price of September Treasury bond futures is 102-20 per $100 of face value, and $100,000 of face value must be delivered against each contract. The value of the DJIA is 7800, and the price of the September CBOT DJIA futures contract is 7839.

The number of T-bond futures to sell is:
Short T-bond futures: $100,000 / (102-04 x $1,000) = 1
(number of futures is rounded to the nearest whole number)

The number of stock index futures to buy is:
Long stock index futures: $100,000 / ($10 x 7800) = 1
(number of futures is rounded to the nearest whole number)

Results: At September futures expiration, the value of the DJIA is 8112, a rate of return of 4%, and the market value of the bonds is 101-08, a rate of return of -1%.

Portfolio Value with No Market Action Taken
STOCKS $200,000 x 1.04 = $208,000
MONEY MARKET + $200,000 x .99 = $198,000
$406,000

Value of Futures Positions
LONG CBOT DJIA FUTURES $10 x 1 x (8112-7839) = $2,730
SHORT BOND FUTURES + $1,000 x 1 x (102-20 - 101-08) = $1,375
$4,105
$410,105

Value of Portfolio with Cash Market Transactions
STOCKS $300,000 x 1.04 = $312,000
BONDS + $100,000 x .99 = $99,000
$411,000

*The difference between the futures and cash-equivalent outcomes are due to the rounding of futures.

Comments: The reallocation of the portfolio involves two steps: The short position in Treasury bond futures converts $100,000 of the investment in Treasury bonds into a $100,000 investment at the money market rate. The long stock index futures position then converts the $100,000 money market investment into a $100,000 investment in stocks. The result is an increase in the final value of the portfolio from $406,000 to $410,105. The same return could have been received with transactions in the cash market but would have involved substantial time, effort, and expense to buy and sell the stocks and bonds. Futures allowed you to take advantage of your market perspective without disrupting your existing portfolio.