Yield-based options

Yield-based options are contracts based on the yield of US Treasury securities, not their market price. The underlying value is set at 10 times the Treasury yield, so if the 30-year Treasury yields 4.5%, the related yield-based option is valued at 45. Common underlying benchmarks include the 13-week T-bill yield (IRX), the 5-year note yield (FVX), the 10-year note yield (TNX), and the 30-year bond yield (TYX).

These options are European-style, meaning they can only be exercised on the expiration date, and they settle in cash rather than through delivery of an actual bond. At exercise, the writer pays the holder the in-the-money amount times the $100 multiplier — no securities change hands.

The key insight is that yield-based options behave opposite to price-based bond strategies. Because bond prices and yields move inversely, an investor who expects interest rates to rise buys yield-based calls, while one who expects rates to fall buys yield-based puts. A portfolio manager holding long-term bonds can hedge against rising rates by purchasing yield-based calls, which gain value as yields climb and bond prices drop.

Yield-based options appear on the Series 7 and Series 9 exams, which test how these contracts settle, the meaning of the underlying yield values, and which positions suit a customer's interest rate outlook. Expect questions that flip the usual price-based logic: with yield-based options, bullish on rates means bullish on calls.