Guide

SOFR futures explained

Harbor Capital parks $95M of operating cash in overnight reverse repo and three-month Treasury bills while waiting for a Q3 acquisition close. The CFO wants protection if the Fed holds rates higher for longer than the desk’s base case — but an OTC forward rate agreement on $95M requires ISDA negotiation, CSA margin calls, and dealer line capacity. Instead, treasury sells forty CME three-month SOFR futures against the September–December accrual window. Each contract references $1 million notional of compounded overnight SOFR; the position gains roughly $2,500 per contract per basis-point rise in implied rates, offsetting the carry drag if overnight funding stays elevated. Execution took twelve minutes on-screen with central clearing — no bilateral credit limit consumed. That trade only makes sense if you understand how SOFR futures price, settle, and differ from the swap and FRA toolkit.

SOFR futures are exchange-traded contracts on the Chicago Mercantile Exchange (CME) whose payoff references the compounded daily Secured Overnight Financing Rate over a defined accrual period. They replaced Eurodollar futures as the dominant short-rate hedge after the LIBOR transition. Unlike Eurodollars, which referenced a forward LIBOR deposit rate, SOFR futures settle against realized overnight repo rates compounded in arrears — matching how most new floating-rate notes and loans actually pay. This guide covers 1-month and 3-month contract mechanics, the price-to-implied-rate formula, settlement and convergence, strip and butterfly structures, convexity versus OTC forwards, the Harbor Capital refactor, a technique decision table, pitfalls, and a production checklist.

Contract specs: 1-month vs 3-month SOFR

CME lists two liquid SOFR futures roots, both quoted as 100 minus the implied rate (the same inverse convention Eurodollar traders used for decades):

1-month SOFR (SR1) — accrual over one calendar month; $4,167 notional per contract (one-twelfth of $1M annual); tick size 0.0025 (= 0.25 bp on rate = $1.04 per tick); monthly listing cycle.
3-month SOFR (SR3) — accrual over three months; $1 million notional per contract; tick size 0.0025 (= 0.25 bp = $6.25 per tick); quarterly March/June/September/December cycle plus serial months.

The implied rate from a futures price is:

implied rate = 100 − futures price

A SR3 contract trading 95.50 implies 4.50% compounded SOFR over the contract’s reference quarter. Because price rises when rates fall, a short futures position (sell) profits when rates rise — the natural hedge for a borrower or cash investor worried about higher funding costs. A long position benefits when rates fall, hedging a lender or fixed-rate asset holder.

Open interest and volume concentrate in SR3; SR1 suits finer monthly hedges on commercial paper programs and money-market fund sleeves. Both clear through CME Clearing with daily mark-to-market and performance bond margins — typically a fraction of OTC initial margin on equivalent FRA notional for investment-grade members.

How settlement works at expiry

SOFR futures are cash-settled at expiry against the arithmetic average of daily SOFR prints over the contract’s reference period (with CME’s published compounding methodology for SR3). There is no physical delivery of collateral or deposits. On the final settlement day:

CME calculates the final settlement rate from realized overnight SOFR observations across the accrual window.
The futures invoice price becomes 100 − final settlement rate (adjusted for any rounding convention in the contract rulebook).
Accounts with open positions receive or pay the difference versus their entry price, times contract multiplier.

Before expiry, the contract trades on expected compounded SOFR. As each business day’s SOFR fixes, uncertainty shrinks — the contract converges toward its terminal value. Traders rolling positions avoid holding through the last days when gamma is low and operational risk of surprise fixes is minimal; corporate hedgers often let positions expire if the accrual window matches their cash exposure exactly.

Term SOFR (CME’s forward-looking benchmark) is a separate index used in some loans and derivatives. SOFR futures reference compounded overnight SOFR, not Term SOFR. Hedging a Term SOFR loan with SR3 futures leaves basis risk between the compounded realized path and the forward-looking term fixings.

Reading the curve: strips, packs, and butterflies

A strip is a sequence of consecutive SOFR futures contracts hedging multiple accrual periods — e.g. selling Dec, Mar, and Jun SR3 to cover a year of quarterly floating exposure. Strips let asset-liability managers match hedge horizon to liability schedules without negotiating a new OTC trade each quarter.

Packs and bundles are CME-listed spreads on four consecutive quarterly contracts, traded as a single order for curve trades. A butterfly (e.g. long 1 nearby, short 2 middle, long 1 deferred) expresses a view on curvature of the short end without taking outright level risk.

The implied rates from adjacent futures imply a forward path of short-term funding. Dislocations between futures-implied forwards and the SOFR-OIS swap curve create basis trades for arbitrage desks — but corporate hedgers should treat those gaps as risk, not free alpha, unless they have systems to monitor convergence.

Convexity and futures vs FRAs

SOFR futures are linear in price for small rate moves, but the relationship between futures prices and forward rates is not identical to OTC forward rate agreements because of convexity and discounting differences:

FRA settlement discounts a single-period rate differential at the start of the accrual window (advance settlement convention on USD FRAs).
Futures margining marks daily to market; the reinvestment of variation margin at overnight rates introduces a convexity bias versus forward rates, especially when volatility is high.

For modest notionals and short horizons (under $50M, under one year), the convexity adjustment is often ignored in corporate hedges. Above $100M or across multi-year strips, treasury teams apply published convexity adjustments or lean on dealer swap desks to convert futures exposure into equivalent FRA or swap risk. The duration guide covers convexity on bonds; the intuition is the same — linear hedges mis-estimate P&L when the curve moves sharply.

Worked example: Harbor Capital quarterly cash hedge

Harbor Capital expects to draw $80M on a revolving credit facility in October, with interest at compounded SOFR + 175 bp. The draw date is uncertain by ± six weeks. Treasury does not want to pay swap breakage if the draw slips, but needs protection if the Fed’s September meeting pushes the short end 50 bp higher.

Position

Sell eighty SR3 December contracts (one per $1M notional) referencing Q4 compounded SOFR. Entry at 95.25 implies 4.75%. If realized Q4 compounded SOFR prints 5.25% at expiry, the contract settles near 94.75 — a 50 bp move worth roughly $10,000 per contract ($80M × 50 bp × 90/360), offsetting higher coupon on the revolver draw.

Roll plan

If the acquisition closes early and the revolver is undrawn, treasury buys back the futures at market (likely at a loss if rates rose) or rolls to the next quarter if the liquidity need shifts. If the draw slips to January, they roll December into March SR3 rather than holding a mismatched accrual window. Daily margin calls are funded from the money market fund sleeve; ops documents the hedge in the ASC 815 memo as a cash-flow hedge of forecast floating interest payments.

Technique decision table

Need	Instrument	Why
Lock one quarterly accrual period, exchange-cleared	3-month SOFR futures (SR3)	Liquid screen market, daily margin, no ISDA required for many members.
Monthly commercial paper or MMF hedge	1-month SOFR futures (SR1)	Finer tenor match than quarterly SR3.
Custom notional and exact date, one period	FRA	OTC flexibility on $37M notional and non-standard fixing dates.
Multi-year fixed-for-floating liability	SOFR interest rate swap	Single trade covers years; futures strips require quarterly rolls.
Cap on worst-case borrowing rate	Interest rate cap or swaption	Asymmetric protection; futures are symmetric linear hedges.
Curve steepener / flattener on short end	SR3 pack or butterfly	Express relative rate views without OTC negotiation.
Hedge Term SOFR loan	Term SOFR swap or FRA on Term SOFR	SR3 compounds overnight SOFR; basis to Term SOFR remains.
Retail investor rate view	T-bill ladder or MMF	Futures require margin account and mark-to-market discipline.

Common pitfalls

Wrong contract month — SR3 accrual windows do not align with calendar quarters on every loan’s interest period; check CME reference dates before trading.
Term SOFR mismatch — hedging a Term SOFR FRN with SR3 leaves uncompensated basis when term fixings diverge from compounded path.
Ignoring margin calls — adverse rate moves require cash variation margin within hours; illiquid treasury ops get forced liquidations.
Convexity on large strips — multi-year SR3 stacks mis-hedge sharp parallel shifts without adjustment versus swaps.
Roll slippage — quarterly rolls cost bid-ask and curve shape risk; budget roll yield in multi-year programs.
Holiday/fixing gaps — SOFR does not fix on U.S. holidays; accrual math differs slightly from ACT/360 loan conventions.
Hedge accounting timing — ASC 815 requires documented hedge relationship at inception; retrofitting designation fails audits.
Double hedging — overlapping FRA plus futures on the same accrual window over-hedges and wastes carry.
Liquidity in back months — deferred serial months trade wider; use quarterly contracts for size.

Production checklist

Confirm loan or asset references compounded overnight SOFR, not Term SOFR.
Map accrual start, end, and fixing dates to CME contract reference period.
Size contracts: SR3 = $1M notional each; SR1 = $4,167 monthly slice.
Convert entry price to implied rate: 100 minus futures price.
Document economic relationship for hedge accounting if electing ASC 815.
Fund margin account with buffer for 2–3 adverse daily moves.
Assign roll calendar before expiry if exposure extends beyond one period.
Reconcile internal forward curve vs CME settlement marks weekly.
Compare futures hedge cost vs OTC FRA or swap all-in (margin + commissions).
Run parallel shift scenario: +25 bp and +50 bp on short end.
Archive trade tickets with contract month, quantity, and entry price.
On expiry, reconcile final settlement rate to NY Fed compounded SOFR publication.

Key takeaways

SOFR futures are exchange-traded hedges on compounded overnight SOFR, quoted as 100 minus implied rate.
SR3 (quarterly) dominates liquidity; SR1 suits monthly accrual matches.
Cash settlement at expiry uses realized daily SOFR over the reference window — positions converge as fixes accumulate.
Harbor Capital used short SR3 to hedge uncertain revolver draws without ISDA negotiation or swap breakage risk.
Futures excel at short, liquid, cleared hedges; multi-year liabilities usually migrate to swaps, caps, or swaptions.