is shorting the put of interest rate more similar to: a shorting the call of bonds or longing the put of bonds?

Short put can be equivalent to a long call. You are expecting the price of the underlying to rise. The payoffs won’t be the same, of course.

Lets try this step by step: 1. a put of interest rates means you are betting that rates go down. 2. if you are short that put, that means the opposite - you want rates to go up. (same as long a call of interest rates) 3. Since rates and bond prices are inverse, when you want rates to go up, that means you want bond prices to fall, so that is the equivalent of a long put position on bonds. Your second choice.

yes, thats right, short put of interest rates == hoping for interest rates going up, if interest rates go up, you are effectively hoping bonds go down. so short put of interest rate is equivalent to simply buying a put on bonds.

In the context of collar, is it more equivalent to shorting the call on the bonds in order to finance the cost of buying the call on the interest rate?

lzhao Wrote: ------------------------------------------------------- > In the context of collar, is it more equivalent to > shorting the call on the bonds in order to finance > the cost of buying the call on the interest rate? You could do it like that, but I don’t believe that would be a collar as CFAI defines it.

I don’t understand why it’s not the first one as well. Shouldn’t both have the same “structural” payoff? For instance: interest rates bonds call shorting longing put longing shorting i.e.: Betting interest rate will go down: shorting call interest rate = longing put interest rates = longing call bond = shorting put bond

adalfu Wrote: ------------------------------------------------------- > I don’t understand why it’s not the first one as > well. Shouldn’t both have the same “structural” > payoff? > > For instance: > > interest rates bonds > call shorting longing > put longing shorting > > i.e.: > Betting interest rate will go down: > shorting call interest rate = longing put interest > rates = longing call bond = shorting put bond That looks right to me.

adalfu Wrote: ------------------------------------------------------- > I don’t understand why it’s not the first one as > well. Shouldn’t both have the same “structural” > payoff? > > For instance: > > interest rates bonds > call shorting longing > put longing shorting > > i.e.: > Betting interest rate will go down: > shorting call interest rate = longing put interest > rates = longing call bond = shorting put bond right, so in the original question, it says to go SHORT a put on interest rates, which is the opposite of what you had written.

i think it is the first choice. put on interest rates is the same as call on bonds because interest rates and bonds are inversely related. so short put on interest rates is equivalent to short call on bonds, and also long put on interest rates is equivalent to long call on bonds. the second one is tempting because you make a profit when the underlying moves in the same direction, so it is tempting to say “short put is somewhat equivalent to long call”. how is that? true you make money when the underlying goes above the strike, but that’s about it in terms of similarities between long call and short put. the payoffs and risks are entirely different.

Mobius, I think your analysis is exactly right!

I misread the first option, but they should be the same no? Mobius, according to your text it would indicate so: long call = short put, so short put on rates = long put on bonds = short call on bonds?

Mobius, can you elaborate more on why the payoffs are different for the two?

draw payoff diagrams and it will be obvious. for instance, the upside profit potential for a long call is unlimited - there is no upper bound on how high the underlying could be. for a short put, your profit is capped - the maximum you can get is the put price you received up front from the long party (if the put expires out-of-the money).

Ah, I was confused about the differences (or rather, lack thereof) between shorting a put and writing a put. Thanks for the clarification.