Getting the ratio right between the long 2-year T-note futures and the short 10-year T-note futures
When yields go down, bond prices go up; when yields go up, bond prices go down. The sensitivity of bond prices to each basis point movement in yield, however, depends, among other things, on the tenor of the bond. The longer the tenor, the more sensitive the bond price to yield movements, other things being equal. As a result, for every one basis point movement, the price change in the 10-year note will be larger than the price change in the 2-year note.
It is important to remember this strategy is to benefit from a steepening of the yield curve but not to bet on the absolute level of yields. Therefore, we need to implement the strategy on a hedge ratio between the 2-year T-note futures and the 10-year T-note future to adjust for the differences in price sensitivity to yield changes. To do that, we want to go long the number of 2-year T-note futures contracts that will move by approximately the same dollar amount in absolute terms against the short in each 10-year T-note futures contract if yields move by the same amount and in the same direction for both tenors. In other words, there will be significant profit and loss only in the case that the magnitudes or directions of the changes in yields for the two contracts are different.
Instead of going through the mathematics to calculate the hedge ratio, a convenient way is to use the futures DV01 at the portal of the CME Group here and click on “2 Yr” under “Deliverables”. The value of futures DV01 means how much the value of one 2-year T-note will change per every basis point movement in yield. For example, In Figure 4, when the 2-year yield falls one basis point, the 2-year futures price will go up approximately by USD34.36. This value will vary as the yield level changes and if there is a shift in the cheapest to deliver bonds. However, for our purposes here, it is sufficient to use this value to calculate the hedge ratio.