Hostname: page-component-cd9895bd7-lnqnp Total loading time: 0 Render date: 2024-12-25T07:46:07.274Z Has data issue: false hasContentIssue false
  • English
  • Français

Quality Option Profits, Switching Option Profits, and Variation Margin Costs: An Evaluation of Their Size and Impact on Treasury Bond Futures Prices

Published online by Cambridge University Press:  06 April 2009

Theodore M. Barnhill
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper provides empirical evidence that the quality option in T-bond futures is much less valuable than previously indicated. In addition, a dynamic trading strategy involving multiple switches of the cash bonds held in a long cash versus short futures position is shown to produce substantially greater profits than the single exercise of the quality option. These findings suggest that the optimal management of long cash/short futures positions is likely to involve dynamic trading strategies while passive strategies appear more appropriate for short cash/long futures positions. It is also shown that required variation margin payments are frequently large and may impact the profitability and risk of such positions to a greater extent than either of these options. Further, evidence is given indicating that observed T-bond futures prices reflect an imputed value for the options and risks inherent in such positions.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 25 , Issue 1 , March 1990 , pp. 65 - 86
Copyright
Copyright © School of Business Administration, University of Washington 1990

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Arak, M., and Goodman, L. S.. “Treasury Bond Futures: Valuing the Delivery Options.” Capital Markets Analysis Group, Citicorp Investment Bank (10. 1985).Google Scholar
Arak, M., and Goodman, L. S.. “How to Calculate Better T-Bond Hedge Ratios.” Futures, 15 (02. 1986), 56–57.Google Scholar
Akemann, C. A. “The Relationship between Implied Yields in T-Bill Futures and T-Bond Futures Spreads.” Working Paper No. 94, Columbia Futures Center (10. 1984).Google Scholar
Akemann, C. A., and Keller, W. E.. “Cash and Carry in Treasury Bond Futures: A Comparison of Two Data Sources.” Working Paper No. 104, Columbia Futures Center (02. 1985).Google Scholar
Barnhill, T. M., and Seale, W. E.. “Optimal Exercise of the Switching Option in Treasury Bond Arbitrages.” Journal of Futures Markets, 8 (10. 1988), 517–532.CrossRefGoogle Scholar
Barnhill, T. M., and Seale, W. E.. “Valuation and Optimal Exercise of the Switching Option in Treasury Bond Cash versus Futures Arbitrages.” Working Paper No. 162, Columbia Futures Center (07 1987).Google Scholar
Barnhill, T. M. “The Delivery Option on Forward Contracts: Comment.” Journal of Financial and Quantitative Analysis, 23 (09. 1988), 337–349.CrossRefGoogle Scholar
Barnhill, T. M., and Jordan, J. V.. “Perspective on Selection of the Optimal Cash Bond for Arbitraging against the Treasury Bond Futures Contract.” Working Paper No. 145, Columbia Futures Center (12. 1986).Google Scholar
Benninga, S., and Smirlock, M.. “An Empirical Analysis of the Delivery Option, Marking to Market, and the Pricing of Treasury Bond Futures.” Journal of Futures Markets, 5 (Fall 1985), 361–374.CrossRefGoogle Scholar
Black, F. “Noise.” Journal of Finance, 41 (07 1986), 529–543.CrossRefGoogle Scholar
Brennan, M. J., and Schwartz, E. S.. “An Equilibrium Model of Bond Pricing and a Test of Market Efficiency.” Journal of Financial and Quantitative Analysis, 17 (09. 1982), 301–329.CrossRefGoogle Scholar
Courtadon, G. “The Pricing of Options on Default-Free Bonds.” Journal of Financial and Quantitative Analysis, 17 (03 1982), 75–100.CrossRefGoogle Scholar
Garbade, K. D., and Silber, W. L.. “Futures Contracts on Commodities with Multiple Varieties: An Analysis of Premiums and Discounts.” Journal of Business, 56 (07 1983), 249–272.CrossRefGoogle Scholar
Gay, G. D., and Manaster, S.. “The Quality Option Implicit in Futures Contracts.” Journal of Financial Economics, 13 (09. 1984), 353–370.CrossRefGoogle Scholar
Gay, G. D., and Manaster, S.. “Implicit Delivery Options and Optimal Delivery Strategies for Financial Futures Contracts.” Journal of Financial Economics, 16 (05 1986), 41–72.CrossRefGoogle Scholar
Hill, J.; Schneeweis, T.; and Mayerson, R.. “An Analysis of Impact of Marking-to-Market in Hedging with Treasury Bond Futures.” Review of Research in Futures Markets, 2 (05 1982), 136–159.Google Scholar
Judge, G. G.; Griffiths, W. E.; Hill, R. C.; and Lee, T. C.. The Theory and Practice of Econometrics, New York: John Wiley and Sons (1980).Google Scholar
Kane, A., and Marcus, A. J.. “Valuation and Optimal Exercise of the Wild Card Option in the Treasury Bond Futures Market.” Journal of Finance, 41 (03 1986), 195–208.CrossRefGoogle Scholar
Kane, A., and Marcus, A. J.. “The Quality of Option in the Treasury Bond Futures Market: An Empirical Assessment.” Journal of Futures Markets, 6 (Summer 1986), 231–248.CrossRefGoogle Scholar
Keith, R. W.; Gay, G.; and Jordan, J. V.. “Are There Arbitrage Opportunities in the Treasury-Bond Futures Market?” Journal of Futures Markets, 2 (Summer 1982), 151–158.Google Scholar
Labarge, K. P. “Daily Trading Estimates for Treasury Bond Futures Contract Prices.” Journal of Futures Markets, 8 (10. 1988), 533–561.CrossRefGoogle Scholar
Livingston, M. “The Cheapest Deliverable Bond for the CBT Treasury Bond Futures Contract.” Journal of Futures Markets, 4 (Summer 1984), 161–172.CrossRefGoogle Scholar
Livingston, M. “The Delivery Option on Forward Contracts.” Journal of Financial and Quantitative Analysis, 22 (03 1987), 79–87.CrossRefGoogle Scholar
Margrabe, W. “The Value of an Option to Exchange One Asset for Another.” Journal of Finance, 33 (03 1978), 177–186.CrossRefGoogle Scholar
Parks, R. W. “Efficient Estimation of a System of Regression Equations when Disturbances Are Both Serially and Contemporaneously Correlated.” Journal of the American Statistical Association, 62 (06 1967), 500–509.CrossRefGoogle Scholar
Rendleman, R. J., and Bartter, B. J.. “The Pricing of Options on Debt Securities.” Journal of Financial and Quantitative Analysis, 15 (03 1980), 11–24.CrossRefGoogle Scholar
Resnick, B. G., and Hennigar, E.. “The Relationship between Futures and Cash Prices for U.S. Treasury Bonds.” Review of Research in Futures Markets, 2 (1983), 283–312.Google Scholar
Sas Institute Inc., Sas/Ets User's Guide Version 5 Edition, Cary, NC: SAS Institute, Inc. (1984).Google Scholar