How to Trade Bond Options

Bond options give you the right to buy or sell bonds at certain prices.

A bond option is a financial instrument that gives traders or investors the right but not the obligation to buy or sell a certain bond at a given price by a certain date. In contrast to stock options, which are similar securities that have stocks as their underlying assets, bond options are not sold on public stock exchanges such as the New York Stock Exchange (NYSE), but are traded on the over-the-counter (OTC) market.

Instructions

1. Learn as much as you can about the bond market in general, and bond options in particular. Identify which factors have an effect on the prices of bonds and bond options (e.g., economic and financial data releases). In what way do those factors influence the price of bond options? Try to learn how to forecast bond options' price movements.

2. Construct your trading strategy for bond options. A trading strategy is a set of guidelines that you will follow in your buy or sell decisions. Choose the time horizons and instruments (certain types of bond options) with which you feel most comfortable. Make sure you understand why the bond options you chose to trade fall or rise in value.

3. Test your strategy using historical data and see how it performs on a demo account, which you can open with any broker that trades bond options. After you find a broker that trades bond options, ask to open a demo account. A demo account is an account that looks like a real one but the funds on it are not real. You can use it to learn about the trading platform of your broker or to test your trading strategy.

4. Open a live account with a broker that trades bond options. Perform additional research on your broker. Check the status of your broker with the regulator of the country where it is based (the Securities and Exchange Commission in the U.S.). Make sure your broker is an established firm with many customers.

5. Start trading bond options, following as closely as possible the strategy you devised. When you start trading, you may be tempted you pursue apparently attractive buying or selling opportunities but you need to forgo those that do not comply with your strategy. Those "opportunities" may turn out to be not as profitable as first appears. At the same time, review your strategy if market conditions change.

References

• Investopedia: Bond Option
• FinPipe.com: How Bonds Trade

Resources

• "Trading and investing in bond options" M. Anthony Wong; 1991
• KGI Securities: Diversified Product Offering
• Interactive Brokers
• SEC: Bonds