Option Greek Rho - does it really matter in Options Trading?

This is a continuation of series of posts on Option Greeks and Options trading strategies. Beginners may first be interested in reading Call and Put Options examples or Options Premium pricing.

Definition of Rho: Options Greek Rho of an option, is the change in the price of the option for 1% change in risk-free interest rate.

How does interest rate affect stock prices and price of an Option?
When I first learned about options and stock market, I had no idea how interest rates come into the picture when pricing stocks and stock market options. Let me deal only with Stock Options. Suppose you want to write a Call Option. Since most people do not write a naked call, lets say you want to write a Covered Call on a particular stock. What would you do? You buy one lot size or contract size of the underlying stock, and then write the covered call. When you buy the underlying, you are investing your money in it. You expectation of the returns from your investment are naturally governed by what the risk free interest rate is. For example, if anyway you can get risk free interest rate of 10% from you savings account, you would not invest in risky stock markets merely hoping for an 8% return on investment, would you? Thus higher the interest rate, more would you charge for your 'investment' made to write the covered call.

Some Characteristics of Options Greek Rho

The above logic also makes the following feature of Options Greek Rho clear.
  1. Options Greek Rho is positive for Call Options.
  2. Options Greek Rho is negative for Put Options.
There are other characteristics of Rho that are important.
  1. The longer the expiration date of the Option, the higher the value of Rho. Thus Rho is more significant for Option Leaps than for Options with one month expiry.
  2. Deep Out of the Money Options have lower value of Rho. While At the Money, and In the Money Options have a relatively higher value of Rho.
Does Rho really matter?
The question is, does rho really matter? You may have noticed that majority of the time, interest rates are more or less constant or show only a minor variation over a small period of time. So if you are dealing with Options with expiry date of one or two months, then I would say it is pretty much harmless to ignore Rho. Note that this does not apply to situations of unstable economies, e.g. recessions or high inflation periods where Governments may announce drastic economic policies to gain control of the situation. In such situations high changes in interest rates are likely.

The most important situation in which Rho matters is when dealing with Options of with expiry dates one or two years away or even more. Such Options with 'far away' expiry dates are sometimes called Options Leaps. While dealing with Options leaps, rho may become significant.

However, in my opinion, for most of the investor's Rho is the least significant among the four Options Greeks.

How to Calculate Options Greek Rho?

The formula to Calculate Options Greeks is a bit complicated. However you can download the following Options Greeks Calculator (Excel Spreadsheet Format) which uses Black-Scholes Method and is good for European style Options.

Download Options Greek Calculator Excel Spreadsheet or Preview
(can be used to calculate Options Greeks Theta, Delta, Vega, Rho and also Options Premium ).

Options Greeks

  • Option Greeks for Beginners (with free Options Calculator)
  • Option Greek Delta and Delta Neutral Options Trading Strategy
  • Option Greek Theta and its role in Options Trading Strategies
  • Option Greek Vega and implied volatility
  • Option Greek Rho - does it really matter in your Options Trading Strategies?
  • Stock Market Derivatives: Futures, Options

  • From Forward contract to Futures.
  • Stock Futures example - Futures trading basics explained.
  • Stock Options trading examples - Call Option Example and Put Option example.
  • Covered Call and Covered Put - Simplest Options trading strategy.
  • Volatility and Options Pricing - How is Option premium priced?
  • Lot Size of a Derivatives Contract - Contract Unit

  • Options Trading Basics
    In the Money Stock Options
    At the Money Stock Options
    Out of the Money Stock Options

    Jun 11, 2009

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