Interest Rate Option Trading

The Chicago Board Options Exchange (CBOE) offers interest rate option trading. CBOE describes interest rate options as “European-style, cash-settled options on the yield of U.S. Treasury securities.” This is one of the kinds of options trading that deals solely in projected interest rates. These options trade in U.S. Treasury bills with short, medium, and long term rates. Options trading terms are the same in trading interest rates as in other options trading.

Interest rate option trading is referred to as trading in yield based options. In trading interest rates on U.S. Treasury bills the individual who buys a call option expects the prevailing interest rate to go up. The individual who buys a put expects the rate to go down. For the buyer of a call option to profit, the underlying interest rate must rise above the strike price by more than the premium paid. For the buyer of a put option to profit, the interest rate must drop below the strike price by at least the price of the premium. In addition, taxes and commissions will figure into the cost analysis for interest rate option trading. For using risk management in options trading the same types of combinations of puts and calls, buys and sells apply as throughout options trading.

Interest rate option trading products offered by CBOE include the thirteen week Treasury bill which trades under the symbol IRX, the five and ten year notes as FVX and TNX, and the thirty year bond as TYX. Strike prices and spot prices in options trading work the same on interest rates as in other options. The buyer profits when the spot price rises or falls from the strike price, depending upon whether he or she purchased a call or a put. The seller is betting that the spot price will not move significantly away from the strike price so that he or she will gain the premium paid for the option and will not lose on a large adverse movement in the interest rate of the  product involved.

Options expiration dates for interest rate option trading at CBOE are the Saturday following the third Friday of the expiration month. The option value of interest rate options is ten times the yield of the underlying security. For example an interest rate of 3% on a 5 year bond makes the option worth $30. Interest rate options trading contracts are settled in cash. There is no need to buy or sell the actual bills, notes, or bonds. Contracts are multiples of 100. In the matter of United States versus other options trading interest rate option trading is done in European style. Thus all contracts are settled on expiration, never before. While the multiplier for contract is 100 the strike price intervals are quoted at every two and a half points as opposed to every five points on a standard strike table. A one point interval is 10 basis points. Premiums are quoted as one point for every $100 and are in decimals.

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