What Is a Wild Card Play?
A wild card play gives the seller of a futures contract, usually Treasury bond futures, the right to give notice of intent to deliver after the closing price of that contract has been set, even though the contract is no longer trading. It is also known as a wild card option.
- A wild card play, usually involving a Treasury bond (T-Bond) futures contract, gives the seller of the contract has the option to give notice of intent to deliver after the closing price of that contract has been set, even after trading has closed.
- A wild card play usually benefits the contract holder if there is a shift 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 implied sequence of six-hour put options, which has been dubbed the "wild card play" or "wild card option."
- Studies have found that real futures traders do not behave optimally in taking advantage of the wild card play.
Understanding Wild Card Plays
A wild card play occurs when a contract holder retains the right to deliver on a futures contract for a given period of time following the close of trading at the closing price. This will end up financially benefiting the contract holder if there is a shift in the value or price of the asset between the time of the closing price and the actual delivery.
Having the right to a wild card play allows the holder to deliver the cheapest to deliver (CTD) issue, regardless of the value of that issue at the time at which the contract expired. The specified time at which delivery can take place varies from contract to contract, depending on the rights granted to the holder of the wild card play. This situation may also occur in other markets or those involving bond options contracts.
History of Wild Card Plays
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 as to when and with which bond the contract will ultimately be settled. The wild card play, or flexible timing option, allows the short position to choose any business day in the delivery month to actually make delivery to the long contract holder.
Additionally, the contract settlement price is fixed in place at 2:00 p.m. on the expiration date of that the futures contract, but the seller need not declare an intent to settle the contract until 8:00 p.m., even though trading in Treasury bonds can occur all day in dealer markets. If bond prices change significantly between 2:00 and 8:00 p.m., the seller has the option of settling the contract at a more favorable price. This phenomenon, which recurs on every trading day of the delivery month, creates an implied sequence of six-hour put options for the short position, which has been dubbed the "wild card play" or "wild card option."
The value of the implied put option relevant to the wild card play was first formalized by Alex Kane and Alan J. Marcus in a 1985 paper for the National Bureau of Economic Research (NBER), although earlier research suggested that, in practice, actual short bond futures participants do not act optimally in taking advantage of the wild card play.
While the value of a wild card play has been formally determined, studies show that futures traders do not behave optimally with these implied options.
Example of a Wild Card Play
Imagine a fictitious short seller, called Hedge Fund A, that takes a short position in U.S. Treasury bonds. In other words, Hedge Fund A borrows a certain quantity of bonds, with the promise to return them at a specified delivery date. On the settlement date, Fund A can opt to use the wild card option in its futures contract.
By exercising the option, Fund A can wait up to six hours after the close of trading to deliver the treasury bonds. If the price falls during those six hours, Fund A can re-purchase the bonds at a discount. If the price rises, Fund A can still settle at the closing price. In both cases, the fund pays the lower price, thereby increasing their profit margins.