I am trying to get a better understanding on the switch option for the WNM4 contract. Usually the wildcard is the only option that’s important for WN but now it’s complicated by the wildcard option. Currently the CTD is a Aug 2049 bond but apparently if rates fall, it could switch to the Nov 2053 bond.

What I am trying to get is a better grasp of is the interplay between the switch option and wildcard option. Each bond has their own wildcard valuation given the conversion factor.

If we assume that at some point, the net basis for both Aug 49 and Nov 53 are similar, one would think that they are equally likely deliverable however if they have different wildcard valuations, does this come into play. For example if Nov 53 has a lower wild card value, is the switch less likely because it’s hard to profit off Nov 53 wildcard.


1 Answer 1


The long future holder is short 3 options to the short future holder. (1) quality option, (2) switch option, (3) timing options--of which the "wild card option" is one.

During the delivery month (same as expiry month), anyone that is short the future can deliver physical bonds to a long future holder. This is why anyone that is long and does not want to take delivery will roll their position into the next contract before the first notice date (1 business day before the delivery month), which is the first date that the long can be notified that they must take delivery.

Futures will continue to trade during the delivery month up to the last week of the delivery month. This is the period where the "quality option" comes into play. Anytime during this period, the cheapest to deliver can change due to interest rate movements. A "switch option" is technically an option where the cheapest to deliver can change after the futures have stopped trading. As such (as will be shown below), there is technically a one day "switch option" between the tender day and the notice day. The largest "switch option" is actually the 1 week period between when futures stop trading and the end of the month by which the short can still notify the exchange that it intends to deliver.

There are 3 important days in the delivery process (1) tender day, (2) notice day, (3) delivery day. The tender day is the day which the short must declare that they intend to deliver--there is a several hour lag between when the futures stop trading and when the short must notify the exchange that they intend to deliver. This is the where the "wild card option" comes to play. The bond market continues trade after the futures market closes and as such, the short can wait to see if it is beneficial to notify the exchange that it intends to deliver. The intraday volatility is what gives the "wild card option" value and even more precisely, the volatility between when the futures market closes and the time by which the short must notify the exchange. By the next day, the short must declare which bond they intend to deliver. During the one day lag, the cheapest to deliver (CTD) can change so the short has a one day "switch option".

It is the interplay between the "wild card option" on the tender day, and the "switch option" between the tender day and the notice day that you are referring to. Since, the short must declare whether or not they intend to deliver the day before they give notice of the precise bond they will deliver, the "wild card option" value is dependent on the "one day switch option". In other words, the short would look to see if there is a possibility that the CTD will change over the next day. If it is highly unlikely that the CTD will change over the next day, then the "wild card option" will only really be dependent on intraday volatility of that one bond. The short will watch the price of this one bond and start to acquire if it falls below the invoice price and give notice on the tender day and for this specific bond on notice day. If there are two bonds that are likely to be the CTD, the short would likely watch both bonds to see if they fall below their respective invoice price before give notice on tender day. And if either one falls below their invoice price, acquire those and then notify the exchange of this particular bond on notice day. The actual CTD bond need not be the one that gets delivered. The intraday volatility of both bonds would come into play when they decide to give notice that they intend to deliver on tender day.

As for the WNM4, I am not sure what you mean by Wild Card value but I assume that this means the wild card option value if that particular bond becomes the CTD (since they are different values as opposed to one “wild card option” value for the futures contract). I would imagine the short would need to take into account the intraday volatility of any bonds that may become the CTD on any given day. If as you say that they are equally likely to be the CTD, then the "wild card option" value of the future would seem to be the average of the wild card value of both of these bonds. On any potential tender day, the “wild card” option would be more valuable for the deliverable bond that has the most intraday volatility. Ideally this is also the CTD bond for the short future holder.

  • $\begingroup$ Hello, I had a related question: when is the highest IRR as a measure not representative of the CTD (assume all bonds trade ar GC)? The reason for my question is: are their cases (such as WNM4) where the bond with the highest IRR is not necessarily the bond that people want to potentially deliver as another bond with a lower CF has a much larger delivery tail, therefore wildcard $\endgroup$
    – user68819
    Mar 13 at 10:27

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