SOFR Futures and Options

CHAPTER 2SOFR Futures

While three-month Eurodollar futures\uline{a} settle to a three-month term rate at the end of the contract, SOFR futures settle to the average of an overnight rate during the last three months prior to the expiration of the contract – referred to as the reference period of the contract. Despite this difference, SOFR futures share several characteristics with Eurodollar futures, since prior to entering the reference period both contracts are functions of the forward rate associated with the reference period. As a result, Eurodollar futures and SOFR futures represent consecutive three-month forward segments of the yield curve – for unsecured borrowing in the case of Eurodollars and for secured borrowing in the case of SOFR. It follows that we can apply many of the same analytic techniques to SOFR futures that have been developed for Eurodollar futures.

Accordingly, this chapter starts by describing the specifications for 3M SOFR futures (SR3), before showing how analytic approaches common to the Eurodollar complex can be applied after the migration to SOFR. It then adds 1M SOFR futures (SR1) and analyzes the spread between 3M and 1M SOFR futures. Finally, it outlines more advanced modeling and hedging techniques via processes, again by building on the work done for LIBOR products.¹

However, once the reference period of a SOFR futures contract begins, the aggregative function stops, and we must keep track of each of the overnight rates that span the reference ...