I read that a long position payoff can be duplicated with a long interest rate call and a short interest rate put… can anyone explain this? And also… if your long an FRA, you profit when the rate increases? Does that differ from a rate swap? Thanks guys, just saw a few questions that I felt were giving conflicting answers…
Long call short put is a synthetic long position in a given underlying. In this case it is interest rate, so long call, short put is a synthetic long in interest rate (so a bet that interest rate will rise). That is essentially same thing as long FRA (where you profit from rising interest rate)
disregard, misread ur question
think about what happens if you’re long an FRA. you benefit if interest rates go up, and lose if they go down. how to get the same effect from interest rate options? the long call means you will benefit from an interest rate rise. but if interest rates fall, nothing happens to you because you simply don’t exercise your option. therefore to get the “other half” of an FRA you also need to write a put, because that will result in you losing if interest rates fall. hope that helps.
definitely does thanks guys