An investor may speculate on interest rates or hedge a portfolio by using rate based options. Rate based options are open for trading, based on the most recently issued Treasury bill, note and bond. Because an investor cannot deliver a “rate”, rate based options settle in cash and use a contract multiplier of 100. Rate based options have a direct correlation to a change in interest rates. An investor who believes that rates will rise would purchase rate based calls or sell rate based puts. An investor who believes that rates are going to fall would purchase rate based puts or sell rate based calls.

Example:

An investor believes that rates are going to rise and purchases 1 March 70 call at 5. The strike price of 70 = an interest rate of 7%

The premium of 5 = 5 x 100 = $500

If rates were to go to 8% by expiration the investor would have a $500 profit

80 - 70 = 10

The 7% call option would be 10 points in the money at expiration and the investor’s account would be credited $1,000. This is found by multiplying the in the money amount by the contract multiplier of 100. Because the investor paid $500 for the option, their profit would be $500.

Rates Up Rates Down Settlement

Priced Based

Options

Buy Puts or

Sell Calls

Buy Calls or

Sell Puts

Underlying

Security is

Delivered

Rate Based

Options

Buy Calls or

Sell Puts

Buy Puts or

Sell Calls

In Cash

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