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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What is a put option and when does a options trader buy or sell put options?

When an options trader thinks that a stock will go up in price he could buy the stock or, for much less, sell a put. When the trader sells the put option he or she receives a premium and undertakes the obligation to buy the stock at an agreed upon price, the exercise price or strike price if the buy wishes. If the price of the stock goes up the buyer of the put will not want to sell and the seller of the put will gain the premium.

If, on the other hand the stock price drops the put buyer will want to exercise his right and the sell will have to buy the stock at the exercise price when, indeed, it may be worth substantially less. Selling a put when one does not have the cash to cover a loss is called an uncovered put or naked put. The downside potential on an uncovered or “naked” put can be the exercise price of the stock if the stock itself goes to zero.

Options traders can buy and sell puts. Buying a put is often a defense strategy for the owner of a large stock position after a substantial run up and a very volatile market. Buy paying the cost of the put the stock owner protects his or her position against substantial loss. Because the buyer of the put is under no obligation to sell his or her stock he or she can pay a little “insurance” to protect a stock position against loss and still control the stock if the price, in fact, goes up.

More complicated approaches to put options are approaches such as long straddles where the options trader will purchase both a call option and a put option on the same stock at the same strike price. The options trader can make money if the stock moves substantially in either direction, and will only lose the price of the options if the stock stands still.

In the case of buying and selling put options a stock owner may be protecting a stock position or a stock trader may be looking to leverage a small amount of capital into a large gain such as with a long straddle. In the case of selling a naked put the options trader is betting on gaining the premium and not losing his or her shirt with a precipitous drop in the stock price.