Why is the most profitable strategy long option free bond and not short putable bond
rates down prices up.
shorting a bond would lose money
Downward parallel shift in the yield curve means that the price of the bond goes up.
The callable bond’s price is lower than the straight bond’s price, because the embedded call option decreases the price. A decrease in rates will increase the straight bond’s price, and it will also increase the call option’s price, which offsets some of the gains.
The putable bond’s price is higher than the straight bond’s price, because the embedded put option increases the price. A decrease in rates will increase the straight bond’s price, but it will decrease the put option’s price, which again offsets some of the gains. However, because we are short this bond, this will be unprofitable regardless.
The straight bond’s price will go up with a decrease in rates, without the funny business involved with the embedded options, which makes it the most profitable option.