Price-Based Option

  

Categories: Derivatives

Commitment is hard. We like to keep our options open. That’s what options are for.

In particular, a price-based option is an option that’s based on the price of the underlying debt security. Most price-based options are based on bonds, and they’re not too popular compared to other options in the space. That’s because yield-based bond options are usually more in line with what people are looking for...based off the yield, rather than the price, of the bond.

Here’s how it works: the holder or a price-based option can (if they want to, by the expiration date) buy (a call option) or sell (a put option) the underlying debt security, at the strike price, which is agreed upon beforehand. As with other options, investors use price-based options either to hedge against risk, or to try to make money off of the spread via speculation. If the price-based option is a bond, it means hedging against changes in price of Treasury securities.

Feeling “secure” yet?

Related or Semi-related Video

Finance: What Is a Put Option?83 Views

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finance a la shmoop what is a put option? hot potato hot potato

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ow ow! yeah remember that game well nobody wanted the potato, poor thing. the

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players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]

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of work the same way. a put option is the right or option or choice to sell a

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stock or a bond at a given price to someone by a certain end date.

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all right example time. you bought netflix stock at the IPO a zillion years

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ago at $1 a share. that's you know splits adjusted. all right now it's a hundred

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bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in

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California that would be a tax of something like almost 40 bucks. well the

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stock was a hundred but you keep only something like 60. feels totally unfair.

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right so you really don't want to sell your stock but you're nervous about the [graph shown]

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next few months that Netflix will crater for a while and go down ten

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maybe twenty dollars. longer term though you think it'll hit 300. so this is the

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perfect setup to maybe look at buying some put options on Netflix. if the stock

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goes down your put options go up. with Netflix volatile but at a hundred bucks

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a share ,you look up the price of an $80 strike price put option expiring in

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December, and you know that's mid-september now .for five bucks a share

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you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]

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term life insurance. you pay the five dollars a share in the stock goes down

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to 82 by mid December, worst of all worlds. well not only did you lose the $5

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a share but your stock has lost $18 in value. but had Netflix really cratered

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and gone to say $60 a share well you would have exercised your put and sold

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your shares at 80 bucks. well those put options you paid $5 for

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would be been worth 15 bucks a share. in buying that put option you've [equation shown]

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guaranteed that your loss will be no more than a $75 value for your Netflix

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position at least for that time period and ignoring taxes. well remember that

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options expire after December whatever like the third Friday of the month it's

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usually when options expire, you then have no protection and your shares float

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along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]

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raunchy. yeah well that's naked put options.

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that's what they really are people.

Up Next

Finance: What Is a Call Option?
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