Most governments find that their spending exceeds their revenues. As an alternative to unpopular tax hikes, governments can raise money through selling government bonds, like U. Treasury bonds , for example. These debt instruments are more popular in times when stock markets look weak as skittish investors seek safer options. One factor that poses a risk to debt instruments is the interest rate in the economy.
As a general rule, when the interest rate goes up, bond prices go down and vice versa. Options related to interest rate instruments like bonds are a convenient way for hedgers and speculators to deal with fluctuating interest rates. Within the category, options on treasury futures are one of the most popular as they are a liquid and transparent way to deal with exposure to interest rate and economic events.
Within futures contracts, the 5-year note, year note and year bond are the most traded in the world. Other than options on futures, there are options on cash bonds. Options contracts typically offer great flexibility as the offer the right rather than the obligation to buy or sell the underlying instrument at a predetermined price and time.
Upon entering an options contract, the option buyer pays a premium. The contract will specify the expiration date of the option and various conditions. For the option buyer, the premium amount is the maximum loss that the buyer will bear while the profit is theoretically unlimited. The case for the option writer the person who sells the option is very different. For the option seller, the maximum profit is limited to the premium received while loss can be unlimited.
In entering an options contract, the buyer is purchasing the right to buy called a call option or to sell called a put option the underlying futures contract. For example, a call option on September year T-Note , gives the buyer the right to assume a long position on it while the seller is obligated to take a short position if the buyer chooses to exercise the option. In the case of a put option, the buyer has the right to a short position in the September year T-Note futures contract while the seller in this case must assume a long position in the futures contract.
An option is said to be covered if the option writer seller holds an offsetting position in the underlying commodity or the futures contract. For example, a writer of a year T-Note futures contract would be called covered if the seller either owns cash market T-Notes or is long on the year T-Note futures contract.
This is riskier than a covered call. While all terms of an option contract are predetermined or standardized, the premium which is paid by the buyer to the seller is determined competitively in the market place and in part depends on the strike price chosen. An option contract would typically specify the price at which the contract can be exercised along with the expiration month. The predefined price level selected for an option contract is called its strike price or exercise price.
Below are the specifications on an option on year U. Chicago time on the last day of trading. The first three consecutive contract months two serial expirations and one quarterly expiration plus the next four months in the quarterly cycle March, June, September and December.
There will always be seven months available for trading. Serials will exercise into the first nearby quarterly futures contract. Quarterlies will exercise into futures contracts of the same delivery period. Options cease trading on the last Friday which proceeds by at least two business days, the last business day of the month proceeding the option month. Options cease trading at the close of trading of the regular daytime open auction trading session for the corresponding year U.
Treasury Note futures contract. If 10 year T-note futures are at , strike prices may be set at 89, 90, 91, 92, 93, 94, 95, etc. The buyer of a futures option may exercise the option on any business day prior to expiration by giving notice to the Board of Trade clearing service provider by 6: Options that expire in-the-money are automatically exercised into a position, unless specific instructions are given to the Board of Trade clearing service provider.
The difference between the strike price of an option and the price at which its corresponding futures contract is trading is called the intrinsic value. A call option will have an intrinsic value when strike price is less than the current futures price. On the other hand, a put option has intrinsic value when strike price is greater than the current futures price.
As a general rule, the greater the time value of an option, the higher the option premium will be. The time value decreases over time and decays as an option contract reaches expiration. The market for options on cash bonds is much smaller and less liquid than that for options on futures. All specifications like strike price, expirations and face value can be customized. Among debt market derivatives, U. These products have wide market participation from around the globe through exchanges such as CME Globex.
Options on debt instruments provide an effective way for investors to manage interest rate exposure and benefit from price volatility. Dictionary Term Of The Day.
A conflict of interest inherent in any relationship where one party is expected to Broker Reviews Find the best broker for your trading or investing needs See Reviews. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. A celebration of the most influential advisors and their contributions to critical conversations on finance.
Become a day trader. Debt Options One factor that poses a risk to debt instruments is the interest rate in the economy. Options on Futures Options contracts typically offer great flexibility as the offer the right rather than the obligation to buy or sell the underlying instrument at a predetermined price and time.
Calls Puts Buy The right to buy a futures contract at a specified price The right to sell a futures contract at a specified price Strategy Bullish: CBOT An option is said to be covered if the option writer seller holds an offsetting position in the underlying commodity or the futures contract. Options on Cash Bonds The market for options on cash bonds is much smaller and less liquid than that for options on futures.
The Bottom Line Among debt market derivatives, U. A conflict of interest inherent in any relationship where one party is expected to act in another's best interests.
Passive investing is an investment strategy that limits buying and selling actions. Passive investors will purchase investments How much a fixed asset is worth at the end of its lease, or at the end of its useful life.
If you lease a car for three years, A target hash is a number that a hashed block header must be less than or equal to in order for a new block to be awarded. No thanks, I prefer not making money. Get Free Newsletters Newsletters. The right to sell a futures contract at a specified price. Obligation to sell a futures contract at a specified price. Obligation to buy a futures contract at a specified price.More...