A bond option refers to an option contract regarding a bond as the underlying asset. It is a financial derivative product that enables investors to make speculative bets on the direction of underlying asset prices. Asset risks can also be hedged within a portfolio.
Options generally have two forms: call options and put options. Call options allow investors to purchase an underlying asset at a particular price. Put options, on the contrary, enable investors to sell an asset at a specific price. Investors can make various speculative positions via bond call or bond put options.
Bond options can be used to achieve different results. For arbitragers, bond options can be used to gain profits through option price discrepancies. For hedgers, bond options can protect the bond portfolio from unfavorable interest rate movements. For speculators, bond options can be traded to profit from favorable movements in prices.
Bond options are more difficult to be found in secondary markets than stocks or other types of option contracts. The options that are found on the secondary market are traded through the counter.
A lot of bond options are embedded. In other words, they can be exercised if the issuer or the investor requests to do so.
Like other financial products, bond options also have risks. Generally, the investors do not have the obligation to exercise, yet non-exercise may lead to a loss of purchase vales and fees of the contracts. Investors who purchase either a call option or a put option can have a maximum loss as much as the option’s purchase value.