can anyone please explain the following:
in a stable yield curve environment one of the strategies is sell convexity by 1)selling put and call options 2)buying bonds with embedded options.
don’t get the second point. In a stable yield curve, won’t bonds with embedded options be not valuable? Why would we want to buy them?!
Buying bonds with embedded options such as Callable bonds means you are short the option.
Remember callable = straight value - call option
Therefore buy buying bonds you ARE short the option and therefore not getting convexity effects.
Got it! Thank you so much!!
Just to build off Rex’s comment and make a little more clear - buying a bond with a call option gives you more yield relative to a bond without a call option (because the call costs the issuer money). So in a stable yield environment you would prefer to earn more yield by giving the issuer a call option because you think that call option is likely to not be exercised.
I think you got it but figured I’d add a little more to the answer.
Makes sense now. Thank you so much!