What is a wild card game?
A wild card game gives the seller of a futures contract, usually Treasury bond futures, the right to notify the intent to deliver after the closing price of that contract has been set, even though the contract is no longer traded. .
- A wild card game, which generally involves a T-Bond futures contract, is where the seller of the contract has the right to notify its intent to deliver after the closing price for that contract has been established. , even after it has been negotiated. closed.
- A wild card game generally benefits the contract holder if there is a change in the value or price of the asset between the time of the closing price and the actual delivery.
- This flexibility that is available to the seller creates an implicit sequence of six-hour put options, which has been called a “wild card game” or “wild card option.”
- Studies have found that real futures traders do not perform optimally when taking advantage of the wild card game.
Understanding Wild Card Games
A wild card game occurs when a contract holder reserves the right to fulfill a futures contract for a specified period of time after the close of trading at the closing price. This will end up financially benefiting the contract holder if there is a change in the value or price of the asset between the time of the closing price and the actual delivery.
Entitlement to a wild card game allows the holder to deliver the cheapest issue to deliver (CTD), regardless of the value of that issue at the time the contract expired. The specified time in which delivery can take place varies from contract to contract, depending on the rights granted to the holder of the wild card game. This situation can also occur in other markets or in those that involve bond options contracts.
History of wild card games
The Chicago Board of Trade (CBOT) Treasury Bond Futures Contract, which was first introduced in 1977, allows several delivery options for holders of short positions on when and with which bond the contract will finally settle. The wild card game, or flex time option, allows the short position to choose any business day in the delivery month to deliver to the long contract holder.
In addition, the settlement price of the contract is set at 2:00 p.m. on the expiration date of the futures contract, but the seller does not need to declare his intention to settle the contract until 8:00 p.m., although the bond trading Treasury can happen all day in dealer markets. If bond prices change significantly between 2:00 and 8:00 pm, the seller has the option to settle the contract at the most favorable price. This phenomenon, which is repeated every trading day of the delivery month, creates an implicit sequence of six-hour put options for the short position, which has been referred to as the “wild card game” or “wild card option”.
The value of the implicit put option relevant to the wild card game was first formalized by Alex Kane and Alan J. Marcus in a 1985 article for the National Bureau of Economic Research (NBER), although previous research suggested that, in In practice, bond futures participants do not perform optimally when taking advantage of the wild card game.
While the value of a wild card game has been formally determined, studies show that futures traders do not perform optimally with these implicit options.
Example of a wild card game
Imagine a fictitious short seller, called Hedge Fund A, that takes a short position in US Treasuries. In other words, Hedge Fund A borrows a certain amount of bonds, promising to pay them back on a certain date. specific delivery. On the settlement date, Fund A may elect to use the wild card option in its futures contract.
When exercising the option, Fund A can wait up to six hours after the close of the trade to deliver the treasury bonds. If the price falls during those six hours, Fund A can buy back the bonds at a discount. If the price rises, Fund A can still be liquidated at the closing price. In both cases, the fund pays the lower price, thus increasing its profit margins.