Description:-
Bond OTC Option is an option contract in which the underlying is a Bond. This underlying could be a single Bond or a Bond index. The buyer of the contract has the option to exercise this contract and take delivery of the underlying or settle the price difference in cash, depending on the settlement mode.
There are two cash flows that are exchanged on any OTC Option deal – the premium amount at the start of the deal and the pay off at expiry.
The party who has bought the option deal would be paying the premium.
Pay Off’s are the final settlement amounts that are to be paid or received from the counterparty depending on the market movements of the underlying.
Type of option contracts,
A Call Option is an option to buy the contract.
A Put Option is an option to sell the contract.
American Option in which the owner is allowed to enter the swap on any day that falls within a range of two dates.
European Option in which the owner is allowed to enter the swap only on the maturity date.
Bermudan Option in which the owner is allowed to enter the swap only certain dates that fall within a range of the start (roll) date and end date.
Why are they traded?
A bond option allows investors the ability to hedge the risk of their bond portfolios or speculate on the direction of bond prices with limited risk.
A buyer of a bond call option is expecting a decline in interest rates and an increase in bond prices.
Life cycle events: –
Premium and pay off’s.
*Pay off = Quantity * (Spot price – Strike) Quantity = 10,000 E.g. Strike price = 1250, Spot price on maturity = 1300. Client is buyer of the option so therefore the pay off would be calculated as (1300-1250) *10,000 = 500,000. Since this is an option trade the pay off would be settled only if the buyer of the trade is in the money. If in case the buyer is Out of the money then the option would be exercised with zero cash.
OTCWIRE 