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I wanted to check my understanding on something. Say bond A (deliverable, but not CTD) goes special (from GC) at some point. What can we say about how its basis should behave?

A. Firstly the bond should richen, therefore, its gross basis should widen (?) B. Also (and I think this is where my confusion is): being long the basis of this bond means that my carry gain/cost is now more +ve/less -ve, which again implies gross basis should widen?

But these are both part of the same effect. The richening of the bonds is due to them being cheaper to hold now with a special repo => my carrying cost of this bond is lower. Therefore, if I wanted to buy a bond with a duration of X, I am more inclined to select that with a special repo, than something on GC => there is a bid for this bond from this angle, causing the richening (as its carry will be better).

Just wanted to clarify my thoughts on this matter. Thank you.

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  • $\begingroup$ I'd also say the impact on ctd basis is similar? To maybe take this a step further, the old 5s (4.125 31/07/28) were trading special around 0.5% in repo. To my fair value curve I see them as being 3bps rich (without any repo adjustment). Assuming i expect them to remain special for 2 weeks, given a monthly carry of 7.2bps => I can probably conclude they are trading at roughly fairvalue if not slightly cheap? But now, we also have the current 5s which look like they're trading very rich to fair value say 5bps. And they're not special. To me all this points to me that the o5s are actually cheap $\endgroup$
    – user68819
    Sep 5, 2023 at 9:55

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You are correct, these are the same effect, although there is a slight twist. If a bond goes special, its price (and therefore the gross basis) will increase by the expected specialness measured over the whole life of the bond. Note that this period exceeds the expiration date of the futures contract, so the price gain probably exceeds what would be calculated simply by estimating the carry improvement prior to futures expiration. Equivalently , the net basis of this bond may also increase. ( Or may not, if the specialness is expected to be very short dated. ). Hope that makes sense.

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  • $\begingroup$ Ah ok that makes sense. So you are saying that there is a part of the basis widening which can be explained by just carry improvements [makes sense]. Then there is another part which can be attributed to the fact that if the bond is expected to remain special well after expiration there may be a further bid for the bond which is unexplained by just the carry differential to futures expiry/delivery => that part feeds into the net basis widening (so net basis here would be some specialness prem + DOV etc)? $\endgroup$
    – user67825
    Sep 3, 2023 at 12:27
  • $\begingroup$ Yes that is correct $\endgroup$
    – dm63
    Sep 3, 2023 at 14:24
  • $\begingroup$ In this case..the repo of a particular bond richening should push it further away from potentially being CTD all else the same? (Sorry a bit basic - but just looking for confirmation) $\endgroup$
    – user68819
    Dec 5, 2023 at 21:59
  • $\begingroup$ I.e. the bond just becomes more expensive to deliver (still trying to intuitively grasp this..) $\endgroup$
    – user68819
    Dec 5, 2023 at 21:59

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