Trading Rho
While it’s possible to trade rho, most traders forgo this niche for more
dynamic strategies with greater profitability. The effects of rho are often
overshadowed by the more profound effects of the other greeks. The
opportunity to profit from rho is outweighed by other risks. For most
traders, rho is hardly ever even looked at.
Because LEAPS have higher rho values than corresponding short-term
options, it makes sense that these instruments would be appropriate for
interest-rate plays. But even with LEAPS, rho exposure usually pales in
comparison with that of delta, theta, and vega.
It is not uncommon for the rho of a long-term option to be 5 to 8 percent
of the option’s value. For example, Exhibit 7.2 shows a two-year LEAPS on
a $70 stock with the following pricing-model inputs and outputs:
EXHIBIT 7.2 Long 70-strike LEAPS call.
The rho is +0.793, or about 5.8 percent of the call value. That means a 25-
basis-point rise in rates contributes to only a 20-cent profit on the call.
That’s only about 1.5 percent of the call’s value. On one hand, 1.5 percent is
not a very big profit on a trade. On the other hand, if there are more rate
rises at following Fed meetings, the trader can expect further gains on rho.
Even if the trader is compelled to wait until the next Fed meeting to make
another $0.20—or less, as rho will get smaller as time passes—from a
second 25-basis-point rate increase, other influences will diminish rho’s
significance. If over the six-week period between Fed meetings, the