www.options-trading-education.com
Profit from Interest Rate Options
Options traders take interest rates into consideration when trading options on stocks, commodities, and foreign exchange. However, it is possible to profit from interest rate options directly as well. Interest rate options are traded on the Chicago Board Options Exchange, CBOE. Options traders can purchase both puts and calls on the spot yield of US Treasury securities. These are traded like European stock options in that they can only be exercised upon expiration of the contract. Nevertheless, options traders can open and close call or put positions throughout the duration of the contract period. Traders who expect interest rates to raise purchase calls and traders who expect interest rates to fall purchase puts. If you choose correctly and profit from interest rate options you receive a cash settlement.
The Numbers
Contract Value
Contracts, like stock options, have a 10 times multiplier times the interest rate yield of the 13 week, 5 year, 10 year, and 30 year US Treasury yield. As with stock options traders purchase options contracts in lots of 100. A 5.7% 10 year US Treasury yield converts to $57 and one purchases calls or puts on 100 contracts which are valued at $5,700. If the 10 year US Treasury rate rises to 6% the 100 contract value rises to $6,000. The call contract profit from interest rate options in this case is $6,000 - $5,700 = $300 minus the cost of the call contract.
Contract Price
If you are going to profit from interest rate options you need to do two things. You need to correctly assess the direction in which interest rates will go. And you need to do so in such a way that the return on your call or put contract is less than the price that you pay for the contract. So, what determines the contract price in interest rate options? Expectation of future value is the answer. If the market expects interest rates to raise it will price call contracts accordingly. If there is very little time remaining before expiration the price of a put or call will essentially be the difference between the strike price and the spot price. The longer there is before expiration of the contract the large is the effect of market sentiment as to future rates. As with trading stock options one can buy calls to lock in opportunity. In this case it would be because the trader expects interest rates to rise.
What Interest Rates Are Traded and Why?
The CBOE offers interest rates options on 13 week Treasuries, 5 Year Treasury Notes, Ten Year notes, and the Thirty Year Treasury Bond. The ticker symbols for these are IRX, FVX, TNX, and TYX. The worldwide market for exchange traded interest rate options is well in excess of $3 Trillion. Although many may choose to speculate in order to profit from interest rate options there are also many investors who will buy options to hedge risk that might be caused by interest rate fluctuation.
2. Options traders take interest
rates into consideration when
trading options on stocks,
commodities, and foreign
exchange.
www.options-trading-education.com
3. However, it is possible to profit
from interest rate options
directly as well.
Interest rate options are
traded on the Chicago Board
Options Exchange, CBOE.
www.options-trading-education.com
4. Options traders can purchase
both puts and calls on the
spot yield of US Treasury
securities.
www.options-trading-education.com
5. These are traded like
European stock options in
that they can only be
exercised upon expiration of
the contract.
www.options-trading-education.com
6. Nevertheless, options traders
can open and close call or put
positions throughout the
duration of the contract
period.
www.options-trading-education.com
7. Traders who expect interest
rates to raise purchase calls
and traders who expect
interest rates to fall purchase
puts.
www.options-trading-education.com
8. If you choose correctly and
profit from interest rate
options you receive a cash
settlement.
www.options-trading-education.com
10. CONTRACT VALUE
Contracts, like stock options,
have a 10 times multiplier
times the interest rate yield of
the 13 week, 5 year, 10 year,
and 30 year US Treasury
yield.
www.options-trading-education.com
11. As with stock options traders
purchase options contracts in
lots of 100.
A 5.7% 10 year US Treasury
yield converts to $57 and one
purchases calls or puts on
100 contracts which are
valued at $5,700.
www.options-trading-education.com
12. If the 10 year US Treasury
rate rises to 6% the 100
contract value rises to $6,000.
The call contract profit from
interest rate options in this
case is $6,000 - $5,700 =
$300 minus the cost of the
call contract.
www.options-trading-education.com
13. CONTRACT PRICE
If you are going to profit from
interest rate options you need
to do two things.
You need to correctly assess
the direction in which interest
rates will go.
www.options-trading-education.com
14. And you need to do so in such
a way that the return on your
call or put contract is less
than the price that you pay for
the contract.
www.options-trading-education.com
15. So, what determines the
contract price in interest rate
options?
Expectation of future value is
the answer.
www.options-trading-education.com
16. If the market expects interest
rates to raise it will price call
contracts accordingly.
www.options-trading-education.com
17. If there is very little time
remaining before expiration
the price of a put or call will
essentially be the difference
between the strike price and
the spot price.
www.options-trading-education.com
18. The longer there is before
expiration of the contract the
large is the effect of market
sentiment as to future rates.
www.options-trading-education.com
19. As with trading stock options
one can buy calls to lock in
opportunity.
In this case it would be
because the trader expects
interest rates to rise.
www.options-trading-education.com
21. The CBOE offers interest rates
options on 13 week
Treasuries, 5 Year Treasury
Notes, Ten Year notes, and the
Thirty Year Treasury Bond.
www.options-trading-education.com
22. The ticker symbols for these
are IRX, FVX, TNX, and TYX.
The worldwide market for
exchange traded interest rate
options is well in excess of $3
Trillion.
www.options-trading-education.com
23. Although many may choose to
speculate in order to profit
from interest rate options
there are also many investors
who will buy options to hedge
risk that might be caused by
interest rate fluctuation.
www.options-trading-education.com
24. In such a situation the trader
will choose an options
expiration date that fits with
his risk hedging.
www.options-trading-education.com
25. If none is available he can also
simply exit an options
contract when his options
contract has done its job.
www.options-trading-education.com
