TITLE:
Reallocating the Right to Choose the Delivery Grade in Futures Markets
AUTHORS:
Shantaram Hegde, Sankarshan Basu, Sunil K. Parameswaran
KEYWORDS:
Futures Valuation, Market Manipulation
JOURNAL NAME:
Theoretical Economics Letters,
Vol.9 No.4,
March
29,
2019
ABSTRACT: We study the futures valuation and market
manipulation implications of reallocating the right to choose the delivery
grade from the short to the long futures position and show that the futures
price will converge to the price of the most expensive-to-deliver grade asset
at delivery. The shifting of the delivery grade option to the long has the
potential to mitigate excessive selling of futures contracts in a crisis, thus
contributing to price stabilization. However, it may distort the incentives for
the longs, leading to large futures and “corner and squeeze” trades to raise the
delivery time spot price above the locked-in futures price.