Interest rates and the option Greeks play an important role in understanding option trading basics. However, we need to be educated in all aspects of our investment strategies and interest rates do play a role. Here is an example from an options calculator showing a positive rho for calls and a negative rho for puts as interest rates increase:. For the day period until expiration, the interest rate is 0. Given that interest rates generally change by 25 basis points when there is an adjustment, the practical impact on our option premiums would be one fourth these amounts.
We can now understand why rho is considered a minor Greek. There is an interest advantage to buying call options. The risk is cut in half and the reward is nearly the same. The higher the interest rates, the more valuable call options become, and so, the rho impacts calls in a positive manner as interest rates rise. There is an interest disadvantage to buying puts. There is a theoretical cost to buying puts, the interest cost to buy the options.
We benefit when share price declines and put value then accelerates in much the way professional traders benefit from shorting stocks. When a stock is shorted, cash is generated into the brokerage account, which will result in an interest credit professional traders do pay some interest for borrowing shares that were shorted. The choice then becomes do these traders pay interest as puts are purchased or do they receive interest as shares are shorted?
As interest rates increase, put-buying becomes less attractive and stock shorting becomes more attractive mainly for professional traders who impact option value much more than we do. Rho is a minor Greek, impacting option premiums as interest rates change. Call and put premiums are impacted inversely as rates rise or fall. Understanding how and why interest rates affect option premiums make us all better investors.
This is a rebroadcast of OICs webinar panel. In this deep dive discussion, Frank Fahey representing Host Joe Burgoyne answers listener questions about mini-options and investor resources. Here is an example from an options calculator showing a positive rho for calls and a negative rho for puts as interest rates increase: Click to Enlarge For the day period until expiration, the interest rate is 0.
Summary Rho is a minor Greek, impacting option premiums as interest rates change.More...