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How To Make A Full-Time Income Trading Less Than Part Time

Big Dogs Exposed

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Newsletter: Playing Options to Capture Interest Rate Swings

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Playing Options to Capture Interest Rate Swings: (as at March 1, 2004)

Were you to assume that U.S. interest rates will rise at some point in the near future, you could easily place your bets by taking advantage of interest rate yield-based options at the CBOE. Such options are European-style, cash-settled options based on the yield of U.S. Treasury securities. Options on short, medium, and long-term rates are available. Included are five-year treasury note options (symbol FVX), 10-year treasury note (TNX) and 30-year treasury bond (TYX). You can check these out by keying in their respective symbols at BigCharts.com.

In the CBOE’s own words, “when yield-based options are purchased, a call buyer and a put buyer have opposite expectations about interest rate movements. A call buyer anticipates that rates will go up, increasing the value of the call position. A put buyer anticipates that rates will go down, increasing the value of the put position. A yield-based call option buyer will profit if, by expiration, the underlying interest rises above the strike price, plus the premium paid for the call. Alternatively, a yield-based put option buyer will profit if, by expiration, the interest rate has declined below the strike price, less the option paid.”

Interest rate options are speculative products, or are used by bondholders to enhance yield. They are not particularly liquid, and the bid-ask spread can be wide.

Valuation for the FVX, TNX and TYX indexes comes in at 10 times the yield-to-maturity on the most recently auctioned five-year, 10-year and 30-year U.S. government treasury notes, respectively.

As at March 1, 2004, for instance, the yield-to-maturity on 30-year treasury bonds was 4.857%. Accordingly, the TYX index closed February 27, 2004 at US$48.57, which was ten times yield-to-maturity.

February 27, 2004, the TYX March 47.50 calls closed at US$1.60. If the TYX yield-to-maturity had gone up to 5% over the ensuing couple of weeks, the TYX index would have been US$50.00 (ten times the yield-to-maturity), and the March 47.50 calls US$2.50

With CBOE interest rate options being cash-settled, you would receive cash for the difference between closing price for the TYX and the strike price of the call (or put) on expiration. The exercise-settlement amount is the difference between the exercise price of the option and the exercise-settlement value, multiplied by US$100.

The yield-to-maturity on the most recently issued T-notes or T-bonds is known as the ‘spot yield.’ The exercise settlement values of interest rate options are determined by the spot yield on the last trading day. Such data is reported by the Federal Reserve Bank of New York at 2:30 p.m. central time.

Information courtesy Richard Croft, National Post, March 2/04.

For information on interest rate indicators, you should look up www.tradingsmarts.com/newsletterinterestrateindicators.htm

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