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Chapter 13

Traded interest rate options

5.1 Basic idea

 Traded interest rate options are options on STIRs – i.e. futures contracts.

5.2 Options hedging calculations

1. Now - set up the hedge

 Call or put options? Borrowing – would sell STIR, so need a put

Depositing – would buy STIR, so need a call
 Which expiry date? First contract to expire after future transaction

 How many contracts? Same as for futures.

 Which strike price? Many different ways of choosing – RTQ.

2. Contact the exchange and pay the premium

3. Future transaction date

 Compare the option price with the prevailing spot rate and make
decision – to exercise or allow to lapse?

 Calculate gain on futures position (if exercised)

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