Bond Option (Reference Data)

ORE describes the trade node as follows:

The BondOptionData node is the trade data container for the option part of a bond option trade type. Vanilla bond options are supported, the exercise style must be European. The BondOptionData node includes one and only one OptionData trade component sub-node plus elements specific to the bond option.

Source: ORE User Guide, Products catalogue, bondoption_refdata.tex.

ORE adds a restriction on the bond form:

Note that only par redemption vanilla bonds are supported.

Source: ORE User Guide, Products catalogue, bondoption_refdata.tex.

A bond option is a vanilla option on a bond that the trade finds in reference data. The buyer names the bond by its identifier, not by a full description. The option is European and the bond must be a plain par bond. The strike can quote a clean or a dirty price.

The BondOptionData node holds one OptionData sub-node plus the strike, the price type, the default behaviour and the underlying bond. LongShort takes Long or Short. OptionType takes Call or Put. A call holder has the right to buy the underlying bond at the strike. A put holder has the right to sell it. The Style is European only. Settlement can be Cash or Physical but is currently ignored. Exactly one ExerciseDate must be given. Premiums is optional. The StrikeData node represents the strike price or strike yield. With StrikePrice, the Value field is expressed per unit notional: a strike of 101 percent of the bond notional is expressed as 1.01. With StrikeYield, the Yield is quoted in decimal form. PriceType is mandatory for StrikePrice and has no impact for StrikeYield. KnocksOut decides the default behaviour. When true, the option knocks out if the underlying defaults before option expiry. When false, the option is written on the recovery value. The BondData block names the bond: SecurityId is typically the ISIN with the ISIN: prefix, BondNotional is the notional in the currency of the bond, and the optional CreditRisk flag decides whether credit risk shows on the product.

The payoff for a bond option is max(B - X, 0), where B is always the dirty NPV of the underlying bond on the exercise settlement date. With PriceType Clean, X is (Strike + Underlying Bond Accruals) x BondNotional. With PriceType Dirty, X is Strike x BondNotional. When StrikeData uses StrikeYield, PriceType is omitted because it is not relevant in the yield case.

• The price and yield of the underlying bond.
• The yield volatility of the bond.
• The strike, quoted as price or yield.
• The interest rates that discount the payoff.
• The credit of the issuer, through the default behaviour.

The bond is fetched from reference data, so the valuation depends on the reference data of the issuer and the bond.

The option is European and ages like a vanilla option. Time value decays toward expiry. If the issuer fails before expiry, the option either knocks out or falls back to the recovery value, as KnocksOut decides. At expiry the payoff is the dirty bond value less the strike, floored at zero.

A bond option gives cheap, leveraged exposure to a government bond without buying it. The reference-data form keeps the trade small, because the bond description lives once in the reference data. In ORE Studio a customer books bond options to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a long European call bond option on a bond from reference data, with the strike per unit notional:

<Trade id="...">
  <TradeType>BondOption</TradeType>
  <Envelope>
      ...
  </Envelope>
  <BondOptionData>
    <OptionData>
     <LongShort>Long</LongShort>
     <OptionType>Call</OptionType>
     <Style>European</Style>
     <ExerciseDates>
      <ExerciseDate>20210203</ExerciseDate>
     </ExerciseDates>
        ...
    </OptionData>
    <StrikeData>
      <StrikePrice>
        <Value>1.23</Value>
      </StrikePrice>
    </StrikeData>
    <PriceType>Dirty</PriceType>
    <KnocksOut>false</KnocksOut>
    <BondData>
       <SecurityId>ISIN:XS1234567890</SecurityId>
       <BondNotional>100000</BondNotional>
    </BondData>
  </BondOptionData>
</Trade>

Source: ORE User Guide, Products catalogue, bondoption_refdata.tex, listing Bond Option data using bond reference data. The source closes the BondData element without the leading slash; it is normalised here.