In finance, an OTC-traded financial instrument that facilitates an option to buy or sell a particular bond at a certain date for a particular price is referred to as bond option. It is identical to a stock option having only one difference and that is the underlying asset is a bond. Black model is used to value bond options.
The bond’s present market value is known as the spot price while the bond’s future value as per the option is known as the strike price.
Types
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An option to buy or sell a bond at a certain date in future for a predetermined price is known as European bond option.
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An option to buy or sell a bond on or before a certain date in future for a predetermined price is known as American Bond option.
Embedded Option
For option-like features of some bonds the term "bond option" is also used. Rather than a separately traded product these are an inherent part of the bond. A bond may have lots of options embedded as these options are not mutually exclusive.
