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Rho

Options involve risk and are not suitable for all investors.
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.

What is Rho?

Rho measures an option's sensitivity to changes in the risk-free rate of interest (the interest rate paid on US Treasury bills) and is expressed as the amount of money an option will lose or gain with a 1% change in interest rates.
Interest rates can have an impact on an option's value as interest rates can impact the cost of carrying the position over time. One should take into consideration the cost of capital. Since this effect is applicable to cost over time, interest rate changes impact longer term options much more than near-term options. The higher the price of the stock and the longer time until expiration generally means a greater sensitivity to changes in interest rates which equates to higher absolute Rho values.
Rho is positive for long calls (right to buy) and increases with the price of the stock. Rho is negative for long puts (right to sell) and approaches zero as the stock price increases. Rho is positive for short puts (obligation to buy), and negative for short calls (obligation to sell).
For illustrative purposes only.

How is Rho used?

Positive Rho

Rho is positive for purchased calls as higher interest rates increase call premiums.
Long calls give the right to purchase stock, normally the cost of that right is less than the fully exercisable value. The difference of those two numbers could be deposited into an interest bearing account. This makes the call options more favorable in a high interest rate environment.
For Example:
Assume XYZ has a current market price of $50.00
Buying Stock Value: Buy 100 Shares XYZ at $50.00 per Share = $5,000.00 Total Cost ($50.00 x 100 Shares)
Buying Call Option: Buy 1 $50.00 Call at $10.00 Premium = $1,000.00 Total Cost ($10.00 Premium X 1 Contract X 100 Shares)
The total exercisable value of this option is $5,000.00 (right to buy 100 shares at $50.00). The cost to purchase the option ($1,000.00) is less upfront capital than the total exercisable value, the remaining $4,000.00 could be deposited and earn interest. This would be positively reflected in the value of the long call option as interest rates increase.

Negative Rho

Rho is negative for purchased puts as higher interest rates decrease put premiums.
Select to close help pop-up an investor is in a short position when the investor sells a stock that he or she does not own.
A long put gives the contract holder the right to sell shares at a pre-determined price for the option's premium — resulting in a debit. When shorting stockHover to view help pop-upSelect to view help pop-upan investor is in a short position when the investor sells a stock that he or she does not own, the seller receives the proceeds from the sale that could be deposited into an interest bearing account. This makes long puts less favorable in a high interest rate environment.
For Example:
XYZ has a current market price of $50.00
Shorting Stock Value: Sell 100 XYZ at $50.00 per Share = $5,000.00 Total Proceeds ($50.00 x 100 Shares)
Buying Put Option: Buy 1 $50.00 Put at $10.00 Premium = $1,000.00 Total Cost ($10.00 Premium X 1 Contract X 100 Shares)
The total exercisable value of this option is $5,000.00 (right to sell 100 shares at $50.00). The cost to purchase the option ($1,000.00) is more upfront capital than the proceeds the total exercisable value would generate. The $5000.00 from the short sale could be deposited and earn interest. This would be negatively reflected in the value of the long put option as interest rates change.

What are other factors to consider?

Interest rate risk is not used in many modern day options tools. Interest rate risk would be applicable in an interest rate environment where the Federal Reserve raises rates by at least 100bps on a regular basis.
Interest rate risk has the greatest effect on longer dated options and is present mainly when holding cash in an interest bearing account is more advantageous. Mainly a concern for LEAP options.
Interest normally moves gradually ~.25%/ quarter. Under normal circumstances it would take a full year to reach a 1% change in interest rates. This of course can change.
Options involve risk and are not suitable for all investors. Certain requirements must be met to trade options. Before engaging in the purchase or sale of options, investors should understand the nature of and extent of their rights and obligations and be aware of the risks involved in investing with options. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options (PDF)" before considering any option transaction. You may also call the Investment Center at 877.653.4732 for a copy. A separate client agreement is needed. Multi-leg option orders are charged one base commission per order, plus a per-contract charge.
View definitions for investment terms in our Glossary.
For purposes of all the computations discussed in this article, commissions, fees and margin interest and taxes, have not been included in the examples. These costs obviously will impact the outcome of any stock or option transaction. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
This material is being provided for informational purposes only. Nothing herein is or should be construed as investment, legal or tax advice, a recommendation of any kind, a solicitation of clients, or an offer to sell or a solicitation of an offer to invest in options. The information herein has been obtained from third-party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed.

Supporting documentation for any claims, comparisons, recommendations, statistics or other technical data will be furnished on request.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
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