Exchange-traded bond options

In a later section we will examine why investors and others might want to use these exchange-traded bond options. Before this, however, we will turn our attention towards the other major exchange-traded interest rate product, short-term interest rate options. 

Calibration to the current spot rate yield curve, using a pre-specified volatility level and not the volatility values given by the prices of exchange-traded optiOTis. This may result in mispriced bonds and options if the selected volatilities are not accurate ... 

This chapter explores interest rate options—a vitat part of the European fixed income securities market. The first section tooks at exchange-traded options, where 20 bittion worth of bond options and over 250 billion of options on short-term rates change hands every day. Next, we ll look at the flexible OTC markets for interest rate options, including caps, collars, swaptions, and structured products. Finally, having explained the products themselves, we ll move on to explore how they can be used to hedge interest rate risk. 

Eurex offers three principal bond option contracts, all of these being options on the futures contracts traded on the same exchange. The contracts available are ... 

As with bond options, each of these options contracts are exercisable into one contract in the underlying futures, also traded on the same exchange. The detailed specifications for EURIBOR STIR options are given in Exhibit 17.11, with those for the other currencies being very similar. However, as the EURIBOR contracts are the most liquid, we will concentrate on these for the remainder of this section. 

Bonds. Exchange-traded options on bonds are invariably written on the bonds futures contracts. One of the most popular exchange-traded options contracts, for example, is the Treasury bond option, which is written on the Treasury futures contract and traded on the Chict o Board of Trade Options Exchange. Options written on actual bonds must be traded in the OTC market. 

The option element in a convertible cannot be stripped out of the bond element, and so is termed an embedded option. The valuation of the bond takes into account this embedded optionality. Note also that unlike a straight equity option, there is no additional payment to make on conversion the holder simply exchanges the bond for the specified number of shares. One could view the price paid for exercising the option as being the loss of the bond element, which is the regular coupon and redemption proceeds on maturity, but this should be viewed as more of an opportunity cost rather than a payment. This bond element is often referred to as the bond floor, which is the straight debt element of the convertible. The bond floor can be viewed as the level at which a vanilla bond issued by the same company would trade, that is, its yield and price. It generally accounts for between 50 percent and 80 percent of the total value. 

American Stock Exchange (AMEX) The second-largest stock exchange in the United States, after the NYSE. Stocks and bonds traded on the AMEX tend to be those of smaller companies than on the NYSE. Some index options and interest rate options trading also occurs on the AMEX. Also called The Curb. 

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