Monday, May 25th, 2020

What Are Options on Interest Rates?

 

Interest rate options are cash settled options on the yield of US Treasuries. What are options on interest rates good for and who trades them? They are European-style in that they are only settled on their expiration date although they can be bought and sold throughout the duration of the contract. Those buying interest rate options are those individuals and companies exposed to currency risk and those seeking to profit from rate changes. What are options on interest rates for those exposed to currency risk? They are a means of hedging risk. What are options on interest rates for those seeking to profit from rate changes? They are a potentially lucrative source of income for those experienced in predicting interest rate changes. What are options on interest rates for those selling options? They are a means of trading options that requires a substantial outlay of capital in order to cover the risk of unexpected changes in rates. They can also be a fairly constant and substantial income stream. How to trade options with interest rates is similar to other options trading. Those who buy calls expect rates to go up and will profit if they do. Those so buy puts expect rates to go down and will profit if they do. Traders pay a premium for buying calls and puts. This premium is the extent of their risk

Interest rate options on short term securities such as 13 week treasuries are based on the spot yield of the security. That is the one time interest payout at maturity. When to buy puts and when to buy calls is based upon how the trader sees the interest rate market. The trader who predicts a rise in interest rates will be hesitant to buy the security, especially if it is long term, as the value of the security will fall as rates rise. He can profit, however, by purchasing a call option on the security. What are options on interest rates for an investor guarding his cash? He could profit from buying a security when rates are likely to go up as the value of the security will rise. However, he may not have the capital to invest. If, though, he has the capital to pay the premium on an interest rate option he can do so and profit when rates go up. Interest rate options are available for short, medium, and long term yields. The interest rates of US treasuries reflect the value of the dollar and economic conditions. People with businesses that are particularly interest rate sensitive can use interest rate options trading to hedge their risk. Obviously those who correctly anticipate interest rates will profit and those whose predictions are inaccurate will lose money. Traders can learn more about interest rate options and trading them by visiting the CBOE web site and downloading their comprehensive PDF file on interest rate options trading. As well as US treasures there are options available on interest rate ETF’s as well. As in all trading taxes and commissions are factors in just how much profit a trader can expect to gain.

More Resources

    Related Educational Products:

    Speak Your Mind

    Tell us what you're thinking...
    and oh, if you want a pic to show with your comment, go get a gravatar!