What Is a Wild Card Option?
Let me explain what a wild card option is—it's a type of option embedded in certain Treasury securities. It allows the seller of a Treasury bond to delay delivery of the underlying asset until after regular trading hours.
This gives the seller an edge because they get a few extra hours to lock in a better price before settling their futures contract.
Key Takeaways
You should know that the term 'wild card option' refers to a right held by the seller of a Treasury bond futures contract. It lets the seller wait until after-hours trading before delivering the bonds to the buyer. This can sometimes result in a more favorable price for the seller, which lowers the cost of their short position and boosts their profits.
How Wild Card Options Work
U.S. Treasury bond futures contracts have been traded on the Chicago Board of Trade (CBOT) since 1977. According to CBOT rules, trading in the Treasury futures market ends at 2:00 pm, but sellers of Treasury futures don't have to settle their contracts until 8:00 pm.
The invoice price—that's the amount the short seller must pay to the futures contract holder—is fixed at 2:00 pm. But with the wild card option, sellers can wait up to six hours, potentially gaining from favorable price shifts in after-hours trading.
When using this option, the seller waits to see if the spot price falls below the invoice price during after-hours. If it does, they can exercise the option and deliver based on that lower spot price, cutting the cost of their short position.
Example of a Wild Card Option
Treasury bond futures are some of the most actively traded securities globally. To show how a wild card option works, consider ABC Capital, a hypothetical investment firm that's shorted the Treasury market by selling bond futures contracts. As the seller, ABC Capital must deliver a set amount of Treasury bonds to the buyer at a specified time.
But on the settlement date, ABC Capital can use the wild card option in their contract. They can wait up to six hours after the trading day ends before deciding to deliver. In those hours, if the bond price drops in after-hours trading, ABC Capital can buy at that lower price and deliver, reducing their short position costs and improving their profit or minimizing losses.
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