Australian Bond Butterfly (2-5-10) Spread

Butterfly Spread is the difference between the mid term structure 5 year rate and the short and long extremes of the yield curve, the 2 year and 10 year rates. The trade is executed by selling the extreme (2 and 10 year contracts) and buying the middle (5 year), or vice versa. The combination of simultaneous buying and selling can lead to a cost effective, even cost neutral trade. The objective of capturing the discrepancy between the middle and extreme's of the yield curve can reflect the stickiness in the short end (with respect to policy rates) and the long end (with regards to inflation expectations and term premiums).

The 2-1-1 weighting scheme is an arbitrary choice, weights can be optimised based on recent yield curve covarance structures.

In 2022 the butterfly spread was strongly positive because although rates were expected to increase, the short end was supressed by quantitative easing, and the long end did not anticipate long term persistent inflation.