Cheapest to Deliver (CTD)
What is the most cost-effective method of delivery?
The phrase "cheapest to deliver" (CTD) refers to the cheapest asset delivered to a long position in a futures contract to meet the contract's requirements. It only applies to contracts that allow for the delivery of a variety of somewhat different securities. This is prevalent in Treasury bond futures contracts, which normally state that any Treasury bond can be delivered as long as it is within a specified maturity range and has a specified coupon rate. The coupon rate is the interest rate that a bond issuer pays during the life of the bond.
TAKEAWAYS IMPORTANT
The cheapest security that can be provided in a futures contract to a long position to fulfil the contract conditions is the cheapest security that can be delivered in a futures contract to a long position.
Treasury bond futures contracts use it frequently.
Because there is a disparity between a security's market price and the conversion factor used to establish its value, determining the cheapest to deliver security is critical for the short position.
Identifying the Lowest Cost of Delivery (CTD)
A futures contract binds the buyer to acquire a particular quantity of an underlying financial item in the future. The seller is required to provide the underlying security on a mutually agreed-upon date. Because a certain grade was not stated in the contract, many financial instruments can meet the contract.
A seller with a short position can determine which instrument will be the most cost-effective to supply.
Remember that a trader takes a short position—or a short—when they sell a financial asset with the purpose of buying it back at a cheaper price later. Traders take short bets when they expect the price of an asset will fall in the near future. Traders can take short bets in futures markets at any time.
Because there is sometimes a mismatch between a security's market price and the conversion factor used to estimate the value of the security being delivered, determining the cheapest to deliver security is critical for the short position. As a result, the seller has an advantage in selecting a certain security to provide over another. It has been since it
. The market pricing of futures contracts is often based on the cheapest to deliver security since it is thought that the short position provides the cheapest to deliver security.
IMPORTANT : There is a widespread belief that the short position is the most cost-effective way to give security.
Particular Points to Consider
The investor in a short position can maximise their return—or profit—on the chosen bond by selecting the cheapest to deliver. The following is the formula for determining the cheapest delivery option:
CTD = Current Bond Price minus Settlement Price multiplied by Conversion Factor
The current bond price is calculated using the current market price plus any interest owing. Furthermore, the inferred repo rate, often known as the net amount received from the transaction, is more typically used in the computations. This is the rate of return a trader may receive by selling a bond or futures contract and simultaneously purchasing the identical asset at market price with borrowed cash. As implied repo rates rise, assets become less expensive to provide overall.
The conversion factor, which is set by the Chicago Board of Trade (CBOT) and the Chicago Mercantile Exchange (CME), is needed to account for the many grades that may be considered and is intended to minimize some benefits that may exist when choosing between different choices. When utilising the data for computations, the conversion factors are updated as needed to offer the most appropriate measure.
