| Title: | Market Investing | 
| Moderator: | 2155::michaud | 
| Created: | Thu Jan 23 1992 | 
| Last Modified: | Thu Jun 05 1997 | 
| Last Successful Update: | Fri Jun 06 1997 | 
| Number of topics: | 1060 | 
| Total number of notes: | 10477 | 
    Here's a semi-hypothetical situation.  I will want to buy a house
    (and a mortgage) in 3 years.  I think interest rates are going to rise
    over the next 3 years, making that mortgage more expensive than it would
    be today.  What is the most cost-effective, least risk way to protect
    myself from interest rates rising over a 3 year period?  Something like
    buying put options on bonds would accomplish this -- as bond prices
    fall (and interest rates rise) the options will rise in value.  Are
    there any such instruments that would cover a 3 year period?  Which
    bonds (treasury, some bond index, etc.) should the option be for?
    Futures are too risky -- if rates fall I don't want to have a potentially
    huge loss.
    Thanks for any ideas. 
    Marc
| T.R | Title | User | Personal Name | Date | Lines | 
|---|---|---|---|---|---|
| 516.1 | CAPs | SUBWAY::DAVIDSON | On a clean disk you can seek forever | Tue Jul 06 1993 10:41 | 3 | 
|     There is an  OTC instrument called an interest rate cap.
    I don;t know how much it would cost or if you could buy one. 
                 
 | |||||
| 516.2 | No futures options that far out | VMSDEV::HALLYB | Fish have no concept of fire | Tue Jul 06 1993 12:39 | 40 | 
|     The short answer is no.  While some futures contracts go out that far,
    no options do.
    
    The contracts to consider are the T-bond contract and T-note contracts
    of various duration.  They have options that go out about a year, so
    you'd have to buy and then roll over.  Which means you still incur a
    certain amount of risk of a gradual rise in rates commensurate with
    implied contract volatility.  But I think that's more a boundary case. 
    If and when rates rise they will probably rise quickly and sharply: 
    all the banks, thrifts and brokers who have been playing the yield curve 
    will run to lock in their interest rate risk.  So if you pursue a
    roll-over course and rates rise sharply, you will likely be covered.
    
    _Barron's_ does a pretty good job of listing futures options.  Bond
    and note \options/ are priced in $K and 64ths, so 2-16 is $2500.
    
    Here's a quick table of translation from bond strike price to interest rate:
    
    Bonds	30-year %
    112		7.03
    110		7.18
    108		7.34
    106		7.49
    104		7.66
    102		7.83
    100		8.00
     98		8.18
     96		8.37
     94		8.56
    
    As you can see, a move from 7% to 8% corresponds to a move from above
    112 to 100 ... over $12,000 value.  This might help you decide what
    strike prices you can afford.
    
    A second consideration would be to look thru (_Barron's_, again) the
    list of LEAP options on stocks, looking for long-term options on
    interest rate sensitive stocks such as banks or Fannie Mae.  That would
    be a different path to consider alone or in conjunction with the above.
    
      John
 | |||||
| 516.3 | BROKE::ZEHNGUT | Wed Jul 07 1993 09:04 | 6 | ||
| John, Thanks for the interesting and informative reply. Seems like there are a lot of different ways to play the interest rate market. Marc | |||||