Call and Put Options

CFA Level II Fixed Income
#1

I have a confusion with call and put options.

Why when a upward sloping curve flattens, call options increase in price and put options do not.

I though options where not affected by interest rate changes only by volatility changes.

Thanks for your help

#2

I believe options are affected by the movement of the underlying and volatility. After all, if rates change you may be in the money, out the money or etc. That means the value of the call option should change.

The interest rate on the other hand is only affected by rate changes and not volatility.

#3

Options are affected by interest rates, this relationship is matched by factor p (rho) among Greek letters. While equity options are less affected by this factor, a bond options are affected. Due to your question, I suppose you’re talking about bonds with embedded options. When yield curve flattens, there is a higher probability that issuer will redeem the issue through a call execution, thus call option increases in value but callable bond price declines.

#4

The question doesn’t make it clear but I thought the post was about floors and caps!

#5

Caps and floors are IR options. Therefore they are affected by IR since its core meaning and underlying is a protection against floating int. rate . Caps mostly protect the borrowers while floors protect the lenders.

#6

double post

#7

For regular equity options, call prices increase with an increase in interest rates. The intuition behind this is that a call option is a form of leverage and gets more expensive when interest rates go up. The reverse is true for put options.

For embedded options in bonds, the value of the embedded call increases as interest rates decline as the issuer will call the bonds and reissue at lower yields. The value of the embedded put decreases as the holder has no incentive to exercise and put his bonds back to the issuer, only to reinvest at current lower rates.

#8

Too many people here ask about (or talk about) intuition when they should be talking about _ understanding _.

If you know the reason, then you have understanding, not merely intuition.