What's the Municipal Over Bond (MOB) Spread?

What is the MOB spread?

-- Sidney J. Friedman

Sidney,

There you go again -- always asking the questions so many are dying to know the answers to, but too proud to ask. You are the sworn enemy of fixed-income ignorance! I salute you.

Ah, the MOB spread. Takes me back to my Bond Buyer days, when the Internet was mewling and puking in the nurse's arms and the Treasury yield curve was positively sloped. (The Bond Buyer, where I was a reporter for a couple of years, is the daily newspaper of the municipal bond market, and the M in MOB stands for municipal.)

So, what is the MOB spread? MOB stands for municipal over bond.

The MOB spread is the difference in price between the municipal bond futures contract listed on the Chicago Board of Trade and the Treasury bond futures contract listed on the same exchange. The muni futures contract is the "municipal" in MOB, and the Treasury contract is the "bond."

The CBOT lists various muni and Treasury contracts, with different expiration dates. Unless otherwise specified, the contracts involved in the MOB spread are the ones that are closest to expiration, without being less than a month from expiration.

The futures contracts roughly track the underlying markets. When the Treasury market is going up in price (when yields are falling), the Treasury futures contract generally also rises. Same with the muni contract.

Thus, the MOB spread rises and falls based on the relative performance of the Treasury and municipal bond markets. When munis are outperforming Treasuries, the muni contract will rise more (or fall less) than the Treasury contract, the MOB spread will rise or widen. Conversely, when the Treasuries are outperforming munis, the MOB spread will fall or narrow.

To profit from a rising MOB spread, a trader would pair a long position in the muni contract with a short position in the Treasury contract. Even if both contracts went down in price, as long as the muni contract outperformed the Treasury contract the trade would be profitable. Conversely, to profit from a falling MOB spread, a trader would pair a short position in the muni contract with a long position in the Treasury contract. Because of its speculative nature, MOB trading is done mainly by professionals.