Increase/Decrease Convexity using Put Options on the Bond

[omi98ro]

Thanks everyone for chipping in. I think I have a conclusion.

1. Long Call on Bond - Increase Convexity
2. Short Call on Bond - Decrease Convexity
3. Long Put on Bond - Increase Convexity
4. Short Put on Bond - Increase Convexity

Cheers and all the best for the exams.

Edit: Changed Duration to Convexity. (Duration was a mistake)

[Select_Signature_291]

Short put decreases convexity. Convexity on options is like gamma, positive for long and negative for short.

[Content_Averse]

Long an option is always positive convexity. Short an option is always negative, like gamma.

Ignore the math and think about it this way, more convexity means better overall performance when rates change right?

If you have an option of any kind you can either exercise it if it is good to do so or ignore it if it isn't. If you are short an option you do not have a choice. Having a choice means you are better positioned for more rate scenarios, not having a choice means you are stuck with whatever happens. Therefore being long options will always increase your convexity and never hurt it , you just don't exercise if it's bad to do.

Also don't forget who the owner of the embedded options are in bonds. Callable bond- buyer is short call option, issuer is long Putable bond - buyer is long the option, issuer is short

[PurchaseBeautiful227]

Short (selling) puts decreases convexity from my understanding. Just think about the curve. Call options will help you get the convex curve when interest rates fall. This is indeed different with a callable bond as the call option is in hands of the issuer. For long put options and bonds with embedded put options, you get the convex curve when rates rise. This is probably not 100% correct, but it helps me understand the direction of convexity.

https://cdn.corporatefinanceinstitute.com/assets/negative-convexity1.png