A Wild Card Option: What Is It?
One kind of option that is buried in specific Treasury securities is called a wild card option. It enables a Treasury bond seller to defer the delivery of the underlying asset until beyond usual business hours.
The seller gains from this choice as it gives them an additional few hours to negotiate a reasonable price before finalizing their futures transaction.
How to Use Wild Card Selections
Since 1977, futures contracts on U.S. Treasury bonds have been traded on the Chicago Board of Trade (CBOT) commodities market.1. Treasury futures market trading ends at 2:00 p.m. under CBOT regulations. However, dealers who have sold Treasury futures are exempt from contract settlement obligations until 8:00 p.m.
The contract’s invoice price, which the short seller must pay the futures contract holder as compensation, is fixed at 2:00 p.m. However, Treasury futures sellers can wait up to six hours due to the wild card option. They may profit from advantageous price fluctuations during after-hours trading during that period.
The seller of the Treasury futures contract would hold off on activating the wild card option until after-hours trading to check whether the spot price drops below the invoice price. Should that occur, the seller may use their wild card option and base their delivery on the low spot price, lowering their short investment’s total expense.
A Wild Card Option Example
One of the financial instruments that is traded the most often worldwide is Treasury bond futures contracts. Consider the example of ABC Capital, a fictitious investment company that has sold Treasury bond futures contracts to take a short position in the Treasury market. This will show how a wild card option works in real life. As the Treasury bond seller, ABC Capital must provide the buyer with a certain number of bonds at a prearranged time. However, ABC Capital may use this card option in its futures contract after the settlement date.
Therefore, ABC Capital may choose to announce its intention to deliver the bonds on the settlement date up to six hours after the conclusion of the trading day. The market price of bonds during after-hours trading may drop during those six hours, allowing ABC Capital to acquire bonds at a lower price before delivering them to the buyer. This would thus increase ABC Capital’s profit or decrease its loss by lowering the cost of its short position.
Conclusion
- The seller of a Treasury bond futures contract has a privilege known as a “wild card option.”
- It allows the seller to hold off on delivering its bonds to the futures contract buyer until after-hours trading.
- On rare occasions, this might result in a better price for the seller, bringing down the expense of their short position and raising their earnings.
