Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Price-Based Option

What it is:

A price-based option is a derivative based on the price of an underlying debt security, usually a bond.

How it works (Example):

A price-based option gives the holder the right, but not the obligation, to purchase or sell (depending on whether the option is a call or a put) the underlying bond for a specific price (the strike price) on or before the option's expiration date. 

For example, let's say you purchase a price-based option on bonds of Intel (INTC) with a strike price of $1,010 and an expiration date of April 16th. This option would give you the right to purchase an Intel bond at a price of $1,010 on or before April 16th (the right to do this, of course, will only be valuable if Intel the bonds are trading above $1,010 per share at that point in time). 

Why it Matters:

Investors use options for two primary reasons -- to speculate and to hedge risk. However, it's important to note that in bond trading, price-based options are no longer very popular; instead, bond options tend to be yield-based.