Wild Card Option

Wild Card Option: Definition, How It Works, and an Example

What is a wild card option?

A wild card option is a contractual right embedded in certain U.S. Treasury futures contracts that allows the seller (the short) to postpone delivery of the underlying Treasury bonds until after regular trading hours. This gives the seller additional time to wait for favorable after-hours price movements before settling the futures contract.

Key takeaways

• The wild card option is held by the seller of a Treasury futures contract.
• It permits delivery to be delayed into after-hours trading, potentially up to six hours.
• If after-hours spot prices move in the seller’s favor, exercising the option can lower the effective cost of the short position, increasing profit or reducing loss.

How it works

Treasury bond futures traded on the Chicago Board of Trade (CBOT) follow a specific timing convention:
* Regular trading in Treasury futures ends at 2:00 pm.
* Settlement (the deadline to deliver) can be postponed until 8:00 pm under the wild card option.
* The futures contract’s invoice price (the price used for settlement) is fixed based on the market at 2:00 pm.

Because the seller can delay delivery after the invoice price is set, they can monitor after-hours trading for up to six hours. If the spot price falls below the invoice price during that period, the seller can exercise the wild card option and deliver based on the lower after-hours price, reducing the cost of covering the short position.

Example

Imagine ABC Capital has sold Treasury bond futures (a short position). At 2:00 pm the invoice price is set, but ABC can wait until 8:00 pm to deliver. If bond prices drop in after-hours trading, ABC can purchase bonds at the lower after-hours spot price and deliver them against the futures contract. That reduces ABC’s net cost on the short position, increasing profit or cutting losses compared with settling at the 2:00 pm invoice price.

When the wild card option matters

The wild card option is valuable to sellers when significant after-hours price movement is possible or expected. It effectively gives shorts optionality to choose the most favorable settlement price within the allowed window, which can materially affect the economics of a futures trade.