You are interested in hedging a portfolio of bonds against a rise in interest rates.Which of the following approaches will be most suitable to your goal?
A)Selling deep ITM vanilla call options and buy deep ITM vanilla put options.
B)Selling deep OTM vanilla call options and buy deep OTM vanilla put options.
C)Selling deep ITM cash-or-nothing calls and buy deep OTM cash-or-nothing calls.
D)None of the above.

Question

Quizplus · Accepted Answer

The first two solutions are the opposite of what is needed as they depreciate when interest rates rise.Deep OTM binary calls have positive rho and deep ITM binary calls have negative rho,so the position in case (c)is a leveraged bet on rates rising.

You Are Interested in Hedging a Portfolio of Bonds Against