Options on Eurodollars to Let Traders Bet on Negative Rates

By Liz Capo McCormick

Jan. 21 (Bloomberg) -- The Chicago Mercantile Exchange is adjusting options on Eurodollar futures to let traders bet on negative interest rates for the first time.

Options on Eurodollars, the world’s most actively traded futures, will be modified Jan. 25 to include strike prices above par, according to CME Group Inc., the parent company of the exchange. The options, were first introduced in March 1988, grant the right but not the obligation to buy or sell the futures contract.

A strike price above par corresponds to an implied yield on the contract at below zero percent. The value of the Eurodollar contract at expiration is determined by the three-month dollar London interbank offered rate, or Libor, and its implied yield represents the market’s forecast. Rates on short-term debt such as Treasury bills traded at negative rates last month as investors sought a haven in U.S. government debt and the Federal Reserve cuts its target interest rate to between zero and 0.25 percent.

“This is sensible contingency planning as you don’t want to be caught out by something that might in other times seem impossible or unexpected,” said Nick Parsons, head of markets strategy in London at NabCapital, a unit of National Australia Bank Ltd., the country’s largest bank. “We’re in an era now where the return of capital is more important than the return on capital.”

Eurodollars are dollars held in commercial banks outside the U.S. The implied yield on the futures contract, which is quoted in price terms, is calculated by subtracting the quoted price from 100. A futures contract is an agreement, to sell or buy a specific amount of a commodity or security at a specific price and time. Three-month dollar Libor was little changed today 1.125 percent.

‘Magical Zero’

“We’re responding to customer demand and are just trying to give them the tools to hedge the risk they have,” said Jeffrey Kilinski, director of interest-rate products at CME Group in Chicago. “The 100 strike has never really come into play before. As we’ve approached par on the futures -- at the magical zero interest rate level -- the usual range of strike prices offered has been truncated.”

The March 2009 Eurodollar futures declined 0.1 percent today to 98.935, for an implied yield of 1.07 percent. Options strikes are expected to be lifted to as high as 104.5 on some of the futures, Kilinski said.

CME Group guidelines state that strike prices on options may be listed up to 5.5 points greater than the current so- called at-the-money futures level, said Kilinski. The at-the- money option strike is the closest to the current price on the underlying Eurodollar futures contract.

To contact the reporter on this story: Liz Capo McCormick in New York at Emccormick7@bloomberg.net

Last Updated: January 21, 2009 10:22 EST

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How much would you PAY to have Goldman hold onto your millions?

 

"Dramatic" strike price additions usually occur at long-term extremes in the market. There ought to be a lot of premium-sellers dying to short-sell the strike prices "at par" and higher believing it's "free money".