A wild card option is a unique feature found in certain Treasury securities. It grants the seller of a Treasury bond the ability to delay the delivery of the underlying asset until after regular trading hours.
This option provides a strategic advantage, allowing sellers extra time to secure a favorable price before finalizing their futures contract settlement.
Key Takeaways
- Wild Card Advantage: A wild card option enables the seller of a Treasury bond futures contract to wait until after-hours trading before executing delivery.
- Strategic Delay: Sellers can capitalize on price fluctuations that occur after regular trading hours, potentially accessing more favorable prices.
- Profit Optimization: This tactic can lower the cost of a short position, thereby increasing the seller’s profits.
How Wild Card Options Work
U.S. Treasury bond futures have been traded on the Chicago Board of Trade (CBOT) since 1977. Under CBOT’s rules, trading concludes at 2:00 pm, but sellers aren’t required to settle their contracts until 8:00 pm. The amount the short seller needs to pay—known as the contract’s invoice price—is determined at 2:00 pm. However, the wild card option allows sellers to wait up to six hours, exploiting any advantageous price movements in after-hours trading.
When wielding the wild card option, sellers watch to see if the spot price drops below the invoice price after-hours. If it does, they can make delivery based on that lower spot price, thus lowering the cost of their short position.
Example of a Wild Card Option
Suppose ABC Capital, a hypothetical investment firm, has a short position in the Treasury market. They are the sellers of Treasury bond futures contracts, obligated to deliver a certain quantity of Treasury bonds at a set time.
On the settlement date, ABC Capital uses the embedded wild card option. They wait for up to 6 hours beyond the close of regular trading before declaring their intent to deliver the bonds. During this period, if after-hours trading sees a drop in bond prices, ABC Capital can buy these bonds at a lower rate, fulfill their contract at this reduced price, and thus lower the cost of their short position, increasing their profit or reducing their loss.
Related Terms: Treasury Securities, Futures Contract, Short Position, Underlying Asset.
References
- Commodity Futures Trading Commission. “History of the CFTC”.
