Wild Card Option
What Is a Wild Card Option?
A wild card option is a type of option that is embedded in certain Treasury securities. It permits the seller of a Treasury bond to delay delivery of its underlying asset until after ordinary trading hours.
This option benefits the seller since it allows them to benefit from a couple of hours' extra time in which to secure a good price before settling their futures contract.
How Wild Card Options Work
U.S. Treasury bond futures contracts have been traded on the Chicago Board of Trade (CBOT) commodity exchange beginning around 1977. Under the rules of the CBOT, trading in the Treasury futures market is terminated at 2:00 pm, yet traders that have sold Treasury futures are not required to settle their contracts until 8:00 pm.
The amount that the short seller must pay to remunerate the holder of the futures contract — known as the contract's invoice price — is set as of 2:00 pm. Due to the wild card option, notwithstanding, Treasury futures sellers have the option of waiting for as long as six hours, during which time they could benefit from positive price developments during after-hours trading.
While practicing the wild card option, the seller of the Treasury futures contract would hold back to see whether the spot price declines below the invoice price during after-hours trading. In the event that it does, the seller could exercise their wild card option and make their delivery in view of the low spot price, decreasing the overall cost of their short position.
Illustration of a Wild Card Option
Treasury bond futures contracts are among the most actively traded investment securities in the world. To show how a wild card option functions in practice, consider the case of ABC Capital, a speculative investment firm that has taken a short position in the Treasury market by selling Treasury bond futures contracts. As the seller of the Treasury bonds, ABC Capital is committed to deliver a predefined quantity of Treasury bonds to the buyer, at a predetermined time. When the settlement date is reached, be that as it may, ABC Capital can opt to utilize the wild card option embedded in its futures contract.
On the settlement date, ABC Capital can thusly hang tight for as long as 6 hours following the finish of the trading day before reporting its expectation to deliver the bonds. During those 6 hours, the market price of bonds during after-hours trading could sink, allowing ABC Capital the opportunity to purchase bonds at a better price before delivering them to the buyer. This thusly would lower the cost of ABC Capital's short position, accordingly expanding their profit or diminishing their loss.
Features
- It permits the seller to hold on until after-hours trading before delivering its bonds to the futures contract buyer.
- This can at times lead to a better price for the seller, lowering the cost of their short position and consequently expanding their profits.
- The term "wild card option" alludes to a right held by the seller of a Treasury bond futures contract.
