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

Need Help Passing Your Series 4 Exam?



Introduction

Related Articles
  1. Trading

    The Basics of Options Profitability

    The adage "know thyself"--and thy risk tolerance, thy underlying, and thy markets--applies to options trading if you want it to do it profitably.
  2. Trading

    Three Ways to Profit Using Put Options

    A brief overview of how to profit from using put options in your portfolio.
  3. Trading

    Trading Options on Futures Contracts

    Futures contracts are available for all sorts of financial products, from equity indexes to precious metals. Trading options based on futures means buying call or put options based on the direction ...
  4. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  5. Trading

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
  6. Trading

    How & Why Interest Rates Affect Options

    The Fed is expected to change interest rates soon. We explain how a change in interest rates impacts option valuations.
  7. Trading

    Going Long On Calls

    Learn how to buy calls and then sell or exercise them to earn a profit.
Frequently Asked Questions
  1. Where else can I save for retirement after I max out my Roth IRA?

    The first option to explore is to determine if you can contribute to a 401(k), 403(b), or 457 plan at work. If your employer ...
  2. How did George Soros "break the Bank of England"?

    In Britain, Black Wednesday (September 16, 1992) is known as the day that speculators broke the pound. They didn't actually ...
  3. What counts as "debts" and "income" when calculating my debt-to-income (DTI) ratio?

    It's important to know your debt-to-income ratio because it's the figure lenders use to measure your ability to repay the ...
  4. Who are Monsanto's main competitors?

    Learn about Monsanto Company's two main operating divisions and its main competitors within each sector, including The Mosaic ...
Trading Center