28 lines
1.6 KiB
Plaintext
28 lines
1.6 KiB
Plaintext
Pricing in Interest Rate Moves
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In the same way that volatility can get priced in to an option’s value, so can
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the interest rate. When interest rates are expected to rise or fall, those
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expectations can be reflected in the prices of options. Say current interest
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rates are at 8 percent, but the Fed has announced that the economy is
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growing at too fast of a pace and that it may raise interest rates at the next
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Federal Open Market Committee meeting. Analysts expect more rate hikes
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to follow. The options with expiration dates falling after the date of the
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expected rate hikes will have higher interest rates priced in. In this situation,
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the higher interest rates in the longer-dated options will be evident when
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entering parameters into the model.
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Take options on Already Been Chewed Bubblegum Corp. (ABC). A
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trader, Kyle, enters parameters into the model for ABC options and notices
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that the prices don’t line up. To get the theoretical values of the ATM calls
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for all the expiration months to sit in the middle of the actual market values,
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Kyle may have to tinker with the interest rate inputs.
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Assume the following markets for the ATM 70-strike calls in ABC
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options:
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Calls Puts
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Aug 70 calls1.75–1.851.30–1.40
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Sep 70 calls2.65–2.751.75–1.85
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Dec 70 calls4.70–4.902.35–2.45
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Mar 70 calls6.50–6.702.65–2.75
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ABC is at $70 a share, has a 20 percent IV in all months, and pays no
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dividend. August expiration is one month away.
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Entering the known inputs for strike price, stock price, time to expiration,
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volatility, and dividend and using an 8 percent interest rate yields the
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following theoretical values for ABC options: |