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

    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 ...
  2. Trading

    The Basics of Options Profitability

    Learn the various ways traders make money with options, and how it works.
  3. Trading

    Getting acquainted with options trading

    Learn about trading stock options, including some basic options trading terminology.
  4. Trading

    Beginners Guide To Options Strategies

    Find out four simple ways to profit from call and put options strategies.
  5. Trading

    Option trading strategies: A guide for beginners

    Options offer alternative strategies for investors to profit from trading underlying securities. Learn about the four basic option strategies for beginners.
  6. 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.
  7. Trading

    Options Hazards That Can Bruise Your Portfolio

    Learn the top three risks and how they can affect you on either side of an options trade.
Frequently Asked Questions
  1. Which Schools Did Warren Buffett Attend?

    Warren Buffett attended multiple prestigious schools on his path to success, but he places much more significance on real-world ...
  2. What are some examples of expansionary monetary policy?

    Learn about expansionary monetary policy and how central banks use discount rates, reserve ratios and purchases of securities ...
  3. What is the role of the nation-state in globalization?

    Learn about the evolving role of the nation-state in an increasingly globalized world as fewer boundaries restrict international ...
  4. What are some examples of positive correlation in economics?

    Learn the most common examples of positive correlation in macroeconomics and microeconomics, including demand and price, ...
Trading Center