Inerest rate caps and floors

CFA Level I
#1

Can someone explain the diff between the foll 1) Long interest rate call 2) Long interest rate put 3) Short interest rate call 4) Short interest rate put THanks

#2

This is what I think…can someone confirm that… 1) Option to borrow in future at a specified rate 2) Option to lend in future at a specified rate 3) Obligation to lend in future at a specified rate 4) Obligation to borrow in future at a specified rate

#3

I am writing this with the hope of getting smashed up, since I never get these concepts right. Part of the reason for writing this out. Long interest rate call I am expecting interest rates to go UP in the future. Today’s rate is 4%, I expect it to go up in future. In that case - I would lose. If I bought a long Interest rate call NOW – when the rate goes up, I would not have to pay the higher rate in the future, and thus I would gain. My gain would be: Notional Amount * (Higher rate in Future - Exercise price (Rate fixed) 4%) * T/360. In case the rate does not go up, I would not exercise my Call option, and let it expire. My maximum loss at that time would be the option premium I paid to get into the Call option. Does that make sense? If so, we can go over the other scenarios.

#4

yes it makes sense now. Right on track cpk

#5

Let’s look at the opposite: Short Interest Rate Call: I am expecting the rate to stay stable at what it is currently. But there is a possibility that it might rise. If it rises, I lose. To protect myself, I sell a Call option on the rate (expecting the rate to stay at 4%). I get paid a premium by the buyer of the above option. (which offsets my losses in case the rate does rise). When the rate rises – I lose. But when the rate falls, I am protected because the option would not be exercised. Basically, I am offsetting my loss on an interest rate rise by getting a bit of a premium. However, in this case, because the rate could rise infinitely, I could potentially continuously LOSE – which I hope would not happen. CP

#6

I think this is the reason , we go long on a interest rate call and short on a interest rate put i.e collar… Long so that we are protected when the interest rate goes above the strike rate and put to offset some of the cost of buying the long option

#7

Hi Everyone,

I know this is an old thread, but fingers crossed youre still around.

I cant seem to get my head around Shorting/Writting interest rate puts.

As the writter, when do I gain or Lose?

Many thanks