interest futures vs options

Bondholder -would use interest futures (sell) when don’t have opinion about the market, to avoid risk -would use options (buy put) when strongly believes that I will go up the reason: futures are cheaper, no premium? correct???

i would agree…

Is this always the case OPTIONS vs FUTURES and FORWARDS don’t have opinion—>FUTURES and FORWARDS have opinion—> options ??? It seems conterintuitive for me: why to give up possibility of upside when you don’t have an opinion with futures and forwards

i think my answer is the CFAI logic but it would make more sense to be unhedged and not pay the premium…

Then tell me what you would do if you strongly believe something is going down… =)

if you don’t have an opinion why not buy a put option and see what happens. You are anyway covered on the downside.

I believe the criteria is whether your priority is to protect against downward movements. In this situation, you always use Futures. Otherwise, best to use options as you have the possibility of capturing some of the upside. Also, as a general rule of thumb for bond portfolios and hedging: - If you believe rates will decline, do nothing. - If you believe rates will rise, buy put options. - If you believe interest rates won’t change much, write a covered call for additional income. - If you have no opinion on rates, sell interest rate futures to avoid risk.

PJ, your general rule of thumb is the answer to the Reading 29 question, but it doesn’t necessarily hold in real life. The only reason it’s the correct answer is they constrained you to match four strategies to four opinions, one-to-one. If you believe rates will decline, buy calls. That’s better than doing nothing isn’t it? But it wasn’t one of the choices.

PJ, there was a very similar question in the CFA text regarding. BTW, what do you mean by selling interest rate futures?

TooOld4This… you’re absolutely right if you’re not worried about duplicating your position. The context is you’re already long bonds. By buying a call option on interest rates you’re duplicating your position and putting more of the portfolio at risk should interest rates not go in the direction expected.

former trader Wrote: ------------------------------------------------------- > PJ, there was a very similar question in the CFA > text regarding. BTW, what do you mean by selling > interest rate futures? Go short interest rate future. Don’t buy it, you sell it. If rates go down you make money, if rates go up you lose money but it’ll be offset by your position in the bond.

If rates go up, dont you lose on your bond portfolio also?

Okay let’s look at it: Long Bond (Effective you’re short interest rates as bond values go up when interest rates decline). Therefore to hedge or hold a neutral position, you would Buy an Interest Rate Future - If rates go up, you lose on the bond but gain on the future. - If rates go down, you gain on the bond but lose on the future. I think the above is a typo… should probably have said BUY interest rate future although I just looked it up in CFAI and they actually say you should sell an interest future which I don’t get because doens’t that essentially duplicate you’re long position in bonds?

Buying calls gives you no more risk on downside and doubles your upside (at a price of course – the call premium). Yep, I’m duplicating my position, but I’m expecting it to pay off when int rates fall. Why wouldn’t I double-down? But that q#3 is a really horrible question – we shouldn’t be wasting our time with it.

Actually, I think interest rate futures means bond futures. The term is interchangeable. Therefore, selling interest rate futures is like selling a bond.

Example of Interest rate future = T-bill Future Maybe you’re thinking of a FRA? If you initiate a FRA and rates rise above your strike rate, you win.

Hmm… would still like clarfication on this… Why does CFAI in the answer state that “selling an interest rate future is appropriate if you have no opinion on rates.” ??? Does selling an interest future mean if rates go down you make money? That’s how I’m taking it. As a result, why would you sell an interest rate future if you’re already long the bond?

I think we are all confused by CFA wording. In mi opinion, a. you have interest rate futures, that increase in value when interest rates increase. if you already hold a bond, in order to hedge, you should buy one of this (as rates go up, your bond goes down but your long futures goes up, and viceversa) b. you have bond futures, that increase in value when interest rates decrease. if you already hold a bond, in order to hedge, you should sell one of this (as rates go up, your bond goes down but your short futures goes up, and viceversa) c. you have interest rates calls, that increase in value when interest rates increase. if you already hold a bond, in order to hedge, you should buy one of this (as rates go up, your bond goes down but your call goes up) d. you have interest rate puts, that increase in value when interest rates decrease. don´t see that these are appropriate for hedging a bond you already have e. you have calls on bonds (I guess not directly, but on bond futures), that increase in value when interest rates decrease. don´t see that these are appropriate for hedging a bond you already have (actually you would be increasing your bet, not hedging), unless you sell them (covered call, but you would give up upside above strike) f. you have put on bonds (again, I guess on bond futures), that increase in value when interest rates increase. if you already have a bond, in order to hedge, you should buy one of this (as rates go up, your bond goes down, but your put goes up) Now the only difference is that if you buy options, as they say, you “buy insurance” and don´t give up any gain on your existing bonds. If you use futures, you “hedge” totally, so you give up any upside. I think the problem with cfa wording is not if “you are sure” or “perhaps”, in order to decide between options and futures, but “about what”. I mean, if we are talking about an increase in rates that will hurt your bond, “if you are sure” = use futures, and “if you are not sure” use options (to keep any upside if you are wrong). For exam purposes, I don´t expect a question where we expect interest rates go down… while we own nothing and must decide between buying a bond, a future, an option… So I would not worry about it. wow… quite a long post… sorry

TooOld4This Wrote: ------------------------------------------------------- > Buying calls gives you no more risk on downside > and doubles your upside (at a price of course – > the call premium). Yep, I’m duplicating my > position, but I’m expecting it to pay off when int > rates fall. Why wouldn’t I double-down? > Because the risk manager won’t let you and the fund manager will fire you. > > But that q#3 is a really horrible question – we > shouldn’t be wasting our time with it.

hala_madrid Wrote: ------------------------------------------------------- > I think we are all confused by CFA wording. > > In mi opinion, > > a. you have interest rate futures, that increase > in value when interest rates increase. if you > already hold a bond, in order to hedge, you should > buy one of this (as rates go up, your bond goes > down but your long futures goes up, and > viceversa) > First, every interest rate future that I know of goes down when interest rates go up. That includes Eurodollar, T-Bill, EURIBOR, Euro-yen, Euro-swiss, Canadian Banker’s acceptance, short sterling, etc… If you are hedging a bond with an interest rate future, you short the futures contract. > b. you have bond futures, that increase in value > when interest rates decrease. if you already hold > a bond, in order to hedge, you should sell one of > this (as rates go up, your bond goes down but your > short futures goes up, and viceversa) > Right and interest rate futures “look like” bond futures. A long eurodollar contract and a long two-year note contract have high positive correlation. > c. you have interest rates calls, that increase in > value when interest rates increase. if you already > hold a bond, in order to hedge, you should buy one > of this (as rates go up, your bond goes down but > your call goes up) > Possibly, but the usual interest rate call is a call on one of those futures contracts (I posted yesterday that the open interest in ED calls was 11,000,000 contracts which represents a notional size of $11 Trillion.) > d. you have interest rate puts, that increase in > value when interest rates decrease. don´t see that > these are appropriate for hedging a bond you > already have > ED Puts are a fine tool for hedging bonds, especially if you have a few different maturities. In general it’s better to use bond futures options, but ED’s target LIBOR and bond futures target govt rates so if your bond is more like LIBOR (i.e., has credit risk) ED options make sense. > e. you have calls on bonds (I guess not directly, > but on bond futures), that increase in value when > interest rates decrease. don´t see that these are > appropriate for hedging a bond you already have > (actually you would be increasing your bet, not > hedging), unless you sell them (covered call, but > you would give up upside above strike) > Note that a call on a bond futures is a cleaner instrument than an option on a bond. It has no counterparty risk and closing the position is easier (if you buy the futures option and exercise, your broker will close out the futures position for no fee if you want him to) > f. you have put on bonds (again, I guess on bond > futures), that increase in value when interest > rates increase. if you already have a bond, in > order to hedge, you should buy one of this (as > rates go up, your bond goes down, but your put > goes up) > > Yep > Now the only difference is that if you buy > options, as they say, you “buy insurance” and > don´t give up any gain on your existing bonds. If > you use futures, you “hedge” totally, so you give > up any upside. > > I think the problem with cfa wording is not if > “you are sure” or “perhaps”, in order to decide > between options and futures, but “about what”. I > mean, if we are talking about an increase in rates > that will hurt your bond, “if you are sure” = use > futures, and “if you are not sure” use options (to > keep any upside if you are wrong). > Anybody who is “sure” about anything about the direction of interest rates is either a) an idiot or b) wildly unbelieveably wealthy. I wouldn’t listen to it for a second. > For exam purposes, I don´t expect a question where > we expect interest rates go down… while we own > nothing and must decide between buying a bond, a > future, an option… So I would not worry about > it. > > wow… quite a long post… sorry