Hi, I am a bit confused by the answers in the mock exam, they seem to be contradicting themselves: This is what the answers were for 2 different questions: 1) When volatility increases, the price of options increase and when interest rates rise, the price of call options is aslo increased. 2) Price of bond with embedded option= Price of option free- value of call option. As interest rates rise, the value of the call option decreases, but by a decreasing amunt relativee to the straight bond. Wouldnt it make sense that if interest rates rise, the value of the call option increases as per the first answer? Thanks!!!
I think you are getting confused. THe first option applies to equities and the second one applies to bond.
The “delta” effect of the change in the price of the bond is a much stronger effect than the “rho” effect of the rising interest rates. In other words, the option loses value much more quickly because of the change in price of the underlier than it gains from increasing interest rates implying that holding calls and cash is desirable.
tryhard Wrote: ------------------------------------------------------- > I think you are getting confused. THe first option > applies to equities and the second one applies to > bond. It’s not so. There is a “rho” effect for bond options too. It’s just drowned out by the delta.
Stalla taught this thing called DIVUTS. It’s pretty helpful. This is what I remember. Dividends Interest Rates Volatility Underlying Price Time to expiration Strike Price Now for a Call it’s: Down, Up, Up, Up, Up, Down. Just draw those arrows next to DIVUTS above. For a Put it’s: Up, Down, Up, Down, Up, Up. Just remember that, and any questions on the test you can’t get wrong. Write it out like 10 times, after that, I promise you it will stick.
Oh and that only applies to Stocks Options, not bonds
Volatility increases the option price for both bonds and stocks. A call option on a bond is basically a call from the regards of the issuer. Price of bond with embedded option = Price of non-callable bond - Price of option An issuer will want to call a bond when rates are dropping so that it can refinance at a lower rate. So when rates drop, the price of the option will rise. If interest rates rise, the value of the option is less for the issuer because it is less likely to call the bond and have to refinance at a higher rate of interest. That’s why the call price drops when interest rates rise.
Here’s a simple formula: P0-C P0+P If interest rates rise, the call option will decrease in value but the value of the call will still be worth something until rates hit a certain level, and then it will be pretty much worthless. The option free bond on the other hand is just a direct function of interest rates as measured by effective duration.
JP_RL_CFA Wrote: ------------------------------------------------------- > Stalla taught this thing called DIVUTS. It’s > pretty helpful. > > This is what I remember. > > Dividends > Interest Rates > Volatility > Underlying Price > Time to expiration > Strike Price > > Now for a Call it’s: Down, Up, Up, Up, Up, Down. > Just draw those arrows next to DIVUTS above. > > For a Put it’s: Up, Down, Up, Down, Up, Up. > > Just remember that, and any questions on the test > you can’t get wrong. > > Write it out like 10 times, after that, I promise > you it will stick. Reminds me back in the days of Street Fighter for SNES, up down up down left right left right AB AB
lol is it sad that I still remember that? Wow remember Contra? lol
lol great, I thought I was the only one who got that. Contra was great, ahh how old I’ve become.
nyccfa2010 Wrote: ------------------------------------------------------- > that. Contra was great, ahh how old I’ve become. I was doing college apps when Pong came out…