In finance, a bond option is an option to buy or sell a bond at a certain price on or before the option expiry date. These instruments are typically traded OTC.
- A European bond option is an option to buy or sell a bond at a certain date in future for a predetermined price.
- An American bond option is an option to buy or sell a bond on or before a certain date in future for a predetermined price.
Generally, one buys a call option on the bond if one believes that interest rates will fall, causing an increase in bond prices. Likewise, one buys the put option if one believes that the opposite will be the case. One result of trading in a bond option, is that the price of the underlying bond is "locked in" for the term of the contract, thereby reducing the credit risk associated with fluctuations in the bond price.
Read more about Bond Option: Valuation, Embedded Options, Relationship With Caps and Floors
Famous quotes containing the words bond and/or option:
“Every doctor will allow a colleague to decimate a whole countryside sooner than violate the bond of professional etiquet by giving him away.”
—George Bernard Shaw (1856–1950)
“A self-respecting nation is ready for anything, including war, except for a renunciation of its option to make war.”
—Simone Weil (1909–1943)