What is Cheapest to Deliver (CTD)?

CTD or the Cheapest to Deliver meaning is used to define the method that helps the investors figure out the Financial Instrument or the cheapest possible security that can prove the most lucrative options in the futures contract. The method is quite commonly used for different types of securities that share a few common features. The best example of the cheapest to deliver is the Treasury bond Futures Contract.

It suggests that any type of treasury bond is fit to be delivered in the futures contract given that it has the maturity rate and coupon rate that matches the specifications of the contract. The coupon rate can be defined as the rate that the company that has issued the bond is supposed to pay throughout the term of the contract. In other words, the issuer will have to pay the coupon rate on the particular bond as long as the contract lasts.

How Does the Cheapest to Deliver or CTD Work?

As soon as the investor signs the future contract, they will be obliged to buy a particular volume of the securities. The contract involves a maturity date, coupon rate, and other conditions that both the buyer and seller have to abide by. The vendor has to deliver the ordered securities as promised. In certain futures contracts, the particular Underlying security is not outlined.

If that is the case, the seller is allowed to sell multiple financial instruments as long as it does not terminate the contract. The issuer of the securities who has the short position can compare different types of financial instruments to decide which one will be the cheapest to deliver.

The formula for calculating the CTD is as follows:

Cheapest to Deliver Security = current Market price of the bond – settlement price x conversion Factor

The short position happens when an individual who sells the financial instrument plans on purchasing these assets back for a lower than the selling price in the future. To put it in simple terms, the seller prefers a short position when they are certain that the rate of the asset or securities they are trading will fall in the future.

One of the biggest advantages of the futures trading market is that it gives traders a chance to have short positions whenever they wish. It is really important for the investors and the issuers to find out the cheapest to deliver security for all kinds of short positions, as the market price and the value of the security delivered in the futures contracts are often different. This makes security trading quite interesting and profitable for the seller, as now they have the option to explore different securities and pick the cheapest security to be delivered.

It is often assumed that the short position offers the cheapest to deliver security. As mentioned above, the main reason why people choose the cheapest to deliver security is to maximize their profits on the bond contracts.