A:

A put option on a bond is a provision that allows the holder of the bond the right to force the issuer to pay back the principal on the bond. A put option gives the bond holder the ability to receive the principal of the bond whenever they want before maturity for whatever reason. If the bond holder feels that the prospects of the company are weakening, which could lower its ability to pay off its debts, they can simply force the issuerer to repurchase their bond through the put provision. It also could be a situation in which interest rates have risen since the bond was intially purchased, and the bond holder feels that they can get a better return now in other investments.

Another benefit to a bond with this provision is that it removes the pricing risk bond holders face when they attempt to sell the bond into the secondary market, where they may have to sell at a discount. The provision adds an extra layer of security for bond holders - as it gives them a safe exit strategy. Because this option is favorable for bond holders, it will be sold at a premium to a comparable bond without the put provision.

Bonds with a put option are referred to as put bonds or putable bonds. This is the opposite of a call option provision which allows the issuer to redeem all of the outstanding bonds. The exact terms and details of the provision is discussed in the bond indenture.

RELATED FAQS

  1. What is a 'busted' convertible bond?

    Learn about busted convertible bonds; these are hybrid securities with conversion prices significantly higher than the market ...
  2. How can I use the holding period return yield to determine whether or not I should ...

    Find out how to use the holding period return yield formula to determine whether it is a good time to sell your bond based ...
  3. Should investors focus more on the current yield or face value of a bond?

    Find out when investors should focus on a bond's current yield versus its face value, including an example of how current ...
  4. What bond indexes follow the supply and demand for junk bonds?

    Learn about indexes that track junk bonds, why junk bonds pay more interest than other types of bonds, and how these bond ...
RELATED TERMS
  1. Strike Width

    The difference between the strike price of an option and the ...
  2. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  3. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  4. Boundary Conditions

    The maximum and minimum values used to indicate where the price ...
  5. Delta-Gamma Hedging

    An options hedging strategy that combines a delta hedge and a ...
  6. Gamma Hedging

    An options hedging strategy designed to reduce or eliminate the ...

You May Also Like

Related Articles
  1. Fundamental Analysis

    20-Year Treasury Bond ETF Trading Strategies

  2. Mutual Funds & ETFs

    ETF Analysis: Direxion Daily 20 Year ...

  3. Retirement

    This is the Top Fear of Gen X, Millennial ...

  4. Mutual Funds & ETFs

    ETF Analysis: iShares Barclays 20+ Year ...

  5. Stock Analysis

    Is Now the Time for Chinese Stocks?

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!