# Cheapest to Deliver (CTD) Explained: Definition, Formula, and Examples

## What Is Cheapest to Deliver?

In futures contracts, cheapest to deliver (CTD) refers to selecting the least expensive security fulfilling the long position’s requirements. It plays a critical role, especially in Treasury bond futures, where a variety of securities can meet contract specifications. Understanding CTD is crucial as it influences the market pricing of futures and how short positions maximize returns.

### Key Takeaways

*   Cheapest to Deliver (CTD) is a term used in futures contracts to denote the least expensive security deliverable to a long position, based on contract specifications.  
    
*   CTD is commonly associated with Treasury bond futures, allowing different bonds to be delivered if they meet specified maturity and coupon rate conditions.  
    
*   For traders with a short position, determining the CTD security is crucial due to price disparities between the market value and the conversion factor.  
    
*   A formula to calculate CTD takes into account the current bond price, settlement price, and a conversion factor, aimed at maximizing returns for the short position.  
    
*   Conversion factors, adjusted by entities like the Chicago Mercantile Exchange, are necessary to account for varying qualities of deliverable securities.

## How the Cheapest to Deliver (CTD) Process Works

A [futures contract](https://www.investopedia.com/terms/f/futurescontract.asp) enters the buyer into an obligation to purchase a specific underlying financial instrument's specific quantity. The seller must deliver the underlying security on a date agreed upon by both parties. In cases where multiple [financial instruments](https://www.investopedia.com/terms/f/financialinstrument.asp) can satisfy the contract based on the fact that a particular grade was not specified, the seller who holds the short position can identify which instrument will be the cheapest to deliver.

Remember, a trader generally takes a short position—or a short—when they sell a financial [asset](https://www.investopedia.com/terms/a/asset.asp) with the intention of repurchasing it at a lower price later on. Traders generally take short positions when they believe an asset's price will drop in the near future. Futures markets allow traders to take short positions at any time.

Determining the cheapest to deliver security is crucial for the short position, as there's often a difference between the market price and the conversion factor of the security delivered. This makes it advantageous for the seller to pick specific security to deliver over another. Since it is assumed that the [short position](https://www.investopedia.com/terms/s/short.asp) provides the cheapest to deliver security, the market pricing of futures contracts is generally based on the cheapest to deliver security.

> **Important**
>
> There is a general assumption that the short position provides the cheapest to deliver security.

## Key Factors in Choosing the Cheapest to Deliver Security

Choosing the cheapest to deliver helps the short investor maximize their profit on the selected bond. The calculation to determine the cheapest to deliver is:

> CTD = Current Bond Price – Settlement Price x Conversion Factor

The current bond price is based on the [market price](https://www.investopedia.com/terms/m/market-price.asp) plus any interest due. Calculations often rely on the net amount earned, called the [implied repo rate](https://www.investopedia.com/terms/i/implied_repo_rate.asp). This is the rate of return that a trader can earn when they sell a bond or futures contract and buy the same asset at the market price with borrowed funds at the same time. Higher implied repo rates result in assets that are cheaper to deliver overall.

The [Chicago Board of Trade](https://www.investopedia.com/terms/c/cbot.asp) and the [Chicago Mercantile Exchange](https://www.investopedia.com/terms/c/cme.asp) set the conversion factor to adjust for different grades and limit advantages when choosing options. The conversion factors are adjusted as necessary to provide the most useful metric when using the information for calculations.

## The Bottom Line

Understanding the concept of cheapest to deliver (CTD) is crucial for those involved in futures contracts, particularly Treasury bond futures. It identifies the most cost-effective security that satisfies contract terms, impacting the profitability of the short position. The CTD is calculated using the formula: CTD = Current Bond Price - Settlement Price x Conversion Factor. This formula helps the short position maximize returns by choosing the security that will yield the highest profit. The conversion factor, set by organizations like CBOT and CME, is essential for adjusting the value of varying securities. Thus, being well-versed with CTD calculations can help traders make informed, strategic decisions in futures markets.