what is yield based option 
a yield based option allows investors to buy or sell calls and puts on the yield of a security rather than its price understanding yield based optionsa yield based option is a contract that gives the buyer the right but not the obligation to purchase or sell at the underlying value which is equal to 10 times the yield yields are expressed as percentage rates and the underlying values for these options contracts are 10 times their yields for example a treasury bond with a yield of 1 6 would have a yield based option with an underlying value of 16 yield based options are settled in cash and they are also called interest rate options a yield based call buyer expects interest rates to go up while a yield based put buyer expects interest rates to go down suppose the interest rate of the underlying debt security rises above the strike rate of a yield based call option in that case the call is in the money for a yield based put the option is in the money when the interest rate falls below the strike rate however yield based option buyers must also pay option premiums when yields increase yield based call premiums increase and yield based put options will lose value yield based options are european options which means that they can only be exercised on the expiration date on the other hand american options can be exercised any time up to the contract s expiration date given that these options are cash settled the writer of the call will simply deliver cash to the buyer that exercises the rights provided by the option the cash amount paid is the difference between the actual yield and the strike yield types of yield based optionssome of the best known yield based options follow the yields of the most recently issued 13 week treasury bills five year treasury notes 10 year treasury notes and 30 year treasury bonds 1 benefits of yield based optionsyield based options are extremely useful for hedging portfolios and profiting in a rising interest rate environment yield based options are one of the few ways to make money when interest rates go up and we will see why from time to time the federal reserve embarks on a campaign of sustained interest rate increases that usually happens because the fed wants to reduce unsustainable price increases driven by speculation in the stock market or commodities markets as interest rates go up investors can get more without taking any risk in the money market that makes the risks of stocks commodities and even bonds less attractive as investors sell risk assets their prices decline which also decreases speculation there were several notable years when the fed repeatedly hiked rates 1981 and 1994 are perhaps the most famous and 2018 is a more recent example 2 in a rising rate environment it is challenging to find any asset with an increasing price however yield based calls especially on 13 week t bill yields are likely to be profitable it is impossible to get the hedging benefits of yield based options from conventional assets like stocks and bonds disadvantages of yield based optionsthere are other ways to get the benefits of yield based options yield based options are certainly less familiar to many investors than options on exchange traded funds etfs buying a put on a long term treasury etf is another way to profit when interest rates go up yield based options also suffer from time decay just like most other options if interest rates stay in place which they can do for years buyers of yield based options will lose money 