Bonds futures and their options: more than the cheapest-to-deliver; quality option and marginning

Henrard, Marc (2006): Bonds futures and their options: more than the cheapest-to-deliver; quality option and marginning. Unpublished.

Abstract

Even if the name futures indicates a simple instrument, bond futures are complex. Several special features are embedded in the instrument. In particular the future is not written on one specific bond but on a basket of bonds, from which the short side can deliver the cheapest. This paper focuses on that feature, present in the main futures market, and its impact on the futures risk. A formula for the delivery option and the convexity adjustment due to the daily margining is proposed in the Gaussian HJM model. The approach is numerically very efficient and easy to implement. Based on this result a futures option formula is derived. The approach is similar to the one used for Canary swaptions.

• Item Type: MPRA Paper
• Additional Information: Part of the material of this work was presented at the Numerical methods in Finance seminar at INRIA Rocquencourt, France in February 2006. AMS mathematics subject classification: 91B28, 91B24, 91B70 The views expressed here are those of the author and not necessarily those of the Bank for International Settlements.
• Language: English
• Keywords: Bond future; option on bond futures; delivery option; marginning; Gaussian HJM model; explicit formula; numerical integration
• Subjects: G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Determination of Interest Rates; Term Structure of Interest Rates

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