Why Aren't the TYX Options More Popular?

I read your article on interest-rate futures. There is another way to trade on interest rates -- using the interest-rate options listed on the Chicago Board Options Exchange. However, looking at the open interest in these options, they don't seem to be very popular at all. I wonder why not.

-- Subodh Nijsure

Subodh,

It's really not all that much of a mystery.

The CBOE's interest-rate options haven't caught on in a big way for two reasons.

First, they're a lot newer than the interest-rate futures and options listed on the Chicago Board of Trade. They're competing with a more firmly established product line.

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Second, the CBOE's options are essentially a retail product, while the CBOT's are essentially institutional. It's a question of the amount of money involved. A CBOE option is on a contract currently worth around $6,400. A CBOT option is on a contract worth $100,000.

Also, among retail investors, there isn't much interest in the bond market these days, never mind interest in hedging or speculating in the bond market, which is what interest-rate options are for.

Let's go over the differences between the two types of interest-rate options.

CBOT Options

The CBOT's interest-rate options are on the exchange's interest-rate futures, which are linked to the price of the 30-year Treasury bond in a somewhat complex fashion discussed at greater length in previous Fixed-Income Forums on July 2 and July 30.

The CBOT's Treasury futures contract, first listed in 1977, requires the holder to take delivery of a $100,000 face amount of Treasury bonds. It's a futures contract, not a bond, so it is quoted in price terms, never in yield terms.

Options on the Treasury futures contract -- both puts and calls -- were first listed in 1982. A call gives the holder the right to buy the contract at a specified strike price, and it rises in value as the contract rises in price, which happens as bond prices rise and yields fall. A put option gives the holder the right to sell the contract at a specified strike price, and it rises in value as the contract falls in price, which happens as bond prices fall and yields rise.

The exchange lists puts and calls as follows: If the contract is trading at 100, puts and calls would be listed at 96, 97, 98, 99, 100, 101, 102, 103, 104. Outside that band, strikes would be listed in 2-point intervals. The CBOT's Web site has the current listing of options on the Treasury contract.

The options can be purchased for as little as $15.625, or 1/64 in price terms, but usually cost much more. (Each full point equals $1,000.)

The options are American-style, meaning they can be exercised at any point prior to expiration, and upon exercise, the holder winds up with a futures position.

CBOE Options

The CBOE's main interest-rate options, first listed in 1993, are on the TYX, the exchange's 30-year Treasury bond index. The index is equal to 10 times the yield of the 30-year Treasury bond. So with the long bond yielding 6.39%, the TYX would be 63.90.

Investors can buy calls or puts on the index. (They can't buy the index itself.) The calls rise in value as the index rises, which in this case happens when bond prices are falling; the index is linked to yield rather than price. Likewise, puts rise in value as the index falls, which happens when bond prices are rising, since rising bond prices mean lower yields.

Strikes are written at 2 1/2-point intervals, where each point represents 10 basis points of yield. For example, puts or calls can be bought with strikes of 55, 57 1/2, 60, 62 1/2, 65, 67 1/2 and 70. A complete list appears on the CBOE's Web site.

The options can be purchased for as little as $6.25, or 1/16, and it's rare to see one priced over $1,000. (Each full point equals $100.)

The options are European-style, meaning they can be exercised at expiration only, and cash-settled. The contract size is $100 times the index, meaning that if the index settles at 64.00 and you have the 60.00 call, you get $100 times the 4 points by which your call is in the money, or $400.

As this chart shows, volume in the TYX options is pretty unimpressive. Even at its peak in 1994, when 187,406 contracts changed hands, the underlying assets were worth only about $1.3 billion. (The average long Treasury yield that year was 7%.) By contrast, the 33 million Treasury options that changed hands at the CBOT this year through the end of November represented an underlying value of $3.3 trillion.

Waning Interest Volume in the Chicago Board Options Exchange's yield-based interest-rate options

*Note: 1999 data through Nov. 30. Source: Chicago Board Options Exchange

I attempted to ask a CBOE market maker in the Treasury options why volume has fallen off so sharply since 1994, but couldn't get one on the phone. Still, it's not all that surprising. The Treasury market had a terrible year in 1994, with the long bond losing 12%, prompting many investors to try to pare their losses or profit from the decline.

From 1995 to 1998, the Treasury market produced healthy to excellent returns, removing the incentive for individual investors to hedge or speculate. This year, the long bond may wind up losing even more than it did in 1994. But the stock market is providing plenty of relief from the bond market's woes. That wasn't the case in 1994.

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