Remembering which interest rate options to use for interest rate expectations

CFA Level III Fixed Income
#1

I’m a bit confused about which interest rate option to use when trying to alter a fixed income interest rate/price exposure. I understand that we use call options when we expect the rate to go up and put options when we expect it to go down, but that is simply from pure memorization. Could someone explain it in a way that makes intuitive sense. I think what’s bogging me down is how I’m so used to valuing an equity option. If you could explain it in those terms then it would make a lot more sense to me as well.

Thank you!

#2

In my opinion, the easiest way to remember which type of option you want in a particular situation is that call options gain when the underlying’s price rises, and put options gain when the underlying’s price falls.

So, if you’re looking at options on a stock:

  • Buy call options if you think that the price of the stock will increase
  • Buy put options if you think that the price of the stock will decrease

If you’re looking at options on a bond:

  • Buy call options if you think that the price of the bond will increase (i.e., that interest rates will go down)
  • Buy put options if you think that the price of the stock will decrease (i.e., that interest rates will go up)

If you’re looking at options on a commodity:

  • Buy call options if you think that the price of the commodity will increase
  • Buy put options if you think that the price of the commodity will decrease

If you’re looking at options on a currency exchange rate:

  • Buy call options on the base currency if you think that the price of the base currency will increase (i.e., that the base currency will appreciate vis-à-vis the price currency)
  • Buy put options on the base currency if you think that the price of the base currency will decrease (i.e., that the base currency will depreciate vis-à-vis the price currency)
  • Buy call options on the price currency if you think that the price of the price currency will increase (i.e., that the base currency will depreciate vis-à-vis the price currency)
  • Buy put options on the price currency if you think that the price of the price currency will decrease (i.e., that the base currency will appreciate vis-à-vis the price currency)

If you’re looking at options on an interest rate:

  • Buy call options if you think that the interest rate will increase
  • Buy put options if you think that the interest rate will decrease

If you’re looking at options on . . . well . . . you get the idea.

#3

Thank you, that helps a lot!

#4

Glad to help.