1
$\begingroup$

I cannot understand the difference between timing option, end of month option and wild card option of bond futures.

i think they are all timing options which is optimal delivery. Only difference is timing option lives between the first delivery and last delivery; end of month option lives between last settlement date and last delivery; wild card lives between future market close and bond market close.

So i cannot find the essential difference btween them.

Improve this question
$\endgroup$
1
  • $\begingroup$ @AlexC I mean the timing option has already covered the wild card and end of month, if you take all of those three options into account for the Future price, your calculation will definitely be repetitive , right? $\endgroup$
    – user6703592
    Mar 18, 2019 at 13:37

1 Answer 1

Reset to default
3
$\begingroup$

The timing option is about when you make delivery and it's more or less worthless. The optimal delivery date, for the most part, boils down to whether or not carry for the cheapest-to-deliver (CTD) is positive. If carry is negative, early delivery is usually optimal. If carry is positive, late delivery is recommended. The edge case is when the switch option (more on this below) is very valuable but carry is negative. Then there's a tug-of-war. If switch option is not valuable enough to offset the negative carry, you'd still deliver early. But if the switch option is very valuable, you might want to deliver later in spite of the negative carry (as soon as you make delivery, you forfeit the switch option completely, assuming it has any value.)

The switch option is about which bond you deliver.

  • Generally speaking / in most models, the switch option (also known as quality option) is about the possibility that the cheapest-to-deliver (CTD) can change between now and the delivery date, where the delivery date is pre-specified to be either the first delivery date or last delivery date, depending on the carry profile (this is not as bad as it sounds, because the timing option, as mentioned above, is pretty much worthless).
  • More complex models might account for the end-of-month option, which is really another switch option (as opposed to being a timing option). Remember that futures price stops changing after the last trade date, but cash bond prices still do. So between the last trade date and the last delivery date, it's possible that the cash market moves by enough that the CTD can change again, after futures have stopped trading. The EOM option is usually worthless too, but for the classic bond contract, it has historically been worth as much 3-5 ticks.

Edited to remove incorrect characterization of the wildcard option. Please refer to @dm63's excellent discussion in the comments below.

Improve this answer
$\endgroup$
6
  • $\begingroup$ so could i understand the timing option optimizes the delivery time between the first delivery day and last delivery day; The optimization of choice of CTD (quality option) can be divided into two parts: wild card lives between the Future market close and underlying market close every day before the last trading day. EOM lives between the last trading day and last delivery day. Wild card and EOM are nothing about the delivery timimg optimization, only for the CTD choice optimization? $\endgroup$
    – user6703592
    Mar 19, 2019 at 7:21
  • $\begingroup$ The switch/quality option is the optionality that the CTD can change between now (trade date) and the delivery date. EOM and wildcard are two of the smallest parts of the total quality option; they're so small they're frequently ignored. Otherwise, your understanding is correct. $\endgroup$
    – Helin
    Mar 19, 2019 at 7:28
  • $\begingroup$ and i asked another question about delivery before last trading day namely we can sell a future then delivery immediately, which is arbitragable. Are you happy to answer this new question? $\endgroup$
    – user6703592
    Mar 19, 2019 at 7:51
  • $\begingroup$ @user6703592 It really isn't. Part of it is because the embedded options might still have value (in fact, even on the last trade day, cash-futures convergence may not occur due to the EOM option). The other part is the usual technicalities (e.g., execution cost, etc.) I also recommend reading about the delivery process (cmegroup.com/trading/interest-rates/files/…). It's not something that can be done as quickly as you think. $\endgroup$
    – Helin
    Mar 19, 2019 at 7:55
  • 1
    $\begingroup$ To clarify something in @Helin otherwise good answer: The wildcard option is not about ctd changing. It is about price movement of the ctd between futures close and last delivery time on a single day within the delivery month. This arises when the ‘conversion factor’ of the CTD is different from 1, so that the holder of the ctd has the option to ‘buy back the tail’ if the market moves significantly between 3pm and 6pm (EST ). So it’s equivalent to a daily option on (1-conversion factor ) amount of bonds. Often it is not worth much but recently it has been important eg in the WN contract. $\endgroup$
    – dm63
    Mar 19, 2019 at 10:19

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.