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Hi Tutor ,
I had a query on the calculations for options on interest rate futures.
My understanding was the future rates for settlement is calculated using the strike price of 96.00, 96.50 .
So for LIBOR -3.8% on May ,for a strike price of 96.00 – the June futures will be 95.97 and for strike price of 96.50 – June futures will be 96.97
But on the answer key – the future rates for May 2013 has been calculated based on the June futures rate on 01 Jan 2013 ( 96.16) – 96.02 & 97.02.So could you please tell me which is the correct way of calculating the June futures on 01 May – is it based on the strike price or the June future 96.16?
Many thanks in advance.
RMRThe option is the right to sell futures at a fixed price (the strike price).
If you do exercise the option, the you will need to buy futures on the date you exercise, in order to immediately sell them.
The profit if exercised is the strike price less the futures price on the date that you exercise.I hope that makes sense 🙂
Dear Tutor ,
My query was how the June futures rate on 01 May calculated – is it based on the strike price or the June futures on 01 Jan ie 96.16?
Many thanks,
RMRThe futures price is completely independent of the strike price – there is no connection at all.
The current price of June futures is 96.16 and the equivalent LIBOR is 100 – 3.3 = 96.70
So the difference at the moment (the basis) is 0.54.We assume always that this basis falls linearly to zero over the life of the future (the future ends on 30 June and on that date the basis will be zero.
If we decide to exercise the options we will have to buy futures on the date the loan starts (1 May) in order that we can immediately sell them at the strike.
From now until the end of the future (30 June) is 6 months. On 1 May there will be only two months left, and so the basis will then be 2/6 x 0.54 = 0.18. So the futures price on 1 May will be 0.18 different than the equivalent LIBOR.
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