Bond plus option
Encyclopedia
In finance, a Bond+Option is a capital guarantee
product that provides an investor with a fixed, predetermined participation to an option
. Buying the zero-coupon bond ensures the guarantee of the capital, and the remaining proceeds are used to buy an option.
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As an example, we can consider a bond+call on 5 years, with Nokia
as an underlying
. Say it is a USD currency
option, and that 5 year rates are 4.7%. That gives you a zero-coupon bond price of
.
Say we are counting in units of $100. We then have to buy $79.06 worth of bond to guarantee the 100 to be repaid at maturity, and we have $20.94 to spend on an option. Now the option price is unlikely to be exactly equal to 20.94 in this case, and it really depends on the underlying. Say we are using the Black–Scholes price for the call, and that we strike the option at the money, the volatility
is the defining part here. A call on an underlying with implied volatility
of 25% will give you a Black–Scholes price of $15.7 while with a volatility of 45%, you'd have to pay $21.76.
Hence the participation would be the proportion you can get with the money you have.
Capital guarantee
A capital guarantee product means that when an investor buys, or "enters", this specific derivative security he is guaranteed to get back at maturity a part or the totality of the money he invested on day one. Examples of capital guarantees include bond plus option, usually bond plus call, and...
product that provides an investor with a fixed, predetermined participation to an option
Option (finance)
In finance, an option is a derivative financial instrument that specifies a contract between two parties for a future transaction on an asset at a reference price. The buyer of the option gains the right, but not the obligation, to engage in that transaction, while the seller incurs the...
. Buying the zero-coupon bond ensures the guarantee of the capital, and the remaining proceeds are used to buy an option.
----
As an example, we can consider a bond+call on 5 years, with Nokia
Nokia
Nokia Corporation is a Finnish multinational communications corporation that is headquartered in Keilaniemi, Espoo, a city neighbouring Finland's capital Helsinki...
as an underlying
Underlying
In finance, the underlying of a derivative is an asset, basket of assets, index, or even another derivative, such that the cash flows of the derivative depend on the value of this underlying...
. Say it is a USD currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...
option, and that 5 year rates are 4.7%. That gives you a zero-coupon bond price of
.Say we are counting in units of $100. We then have to buy $79.06 worth of bond to guarantee the 100 to be repaid at maturity, and we have $20.94 to spend on an option. Now the option price is unlikely to be exactly equal to 20.94 in this case, and it really depends on the underlying. Say we are using the Black–Scholes price for the call, and that we strike the option at the money, the volatility
Volatility (finance)
In finance, volatility is a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices...
is the defining part here. A call on an underlying with implied volatility
Implied volatility
In financial mathematics, the implied volatility of an option contract is the volatility of the price of the underlying security that is implied by the market price of the option based on an option pricing model. In other words, it is the volatility that, when used in a particular pricing model,...
of 25% will give you a Black–Scholes price of $15.7 while with a volatility of 45%, you'd have to pay $21.76.
Hence the participation would be the proportion you can get with the money you have.
- In the 25% vol case you get a 133% participation
- In the 45% vol case, 96%.