What is a Price-Based Option?
A price-based option is a derivative based on the price of an underlying debt security, usually a bond.
How Does a Price-Based Option Work?
A price-based option gives the holder the right, but not the obligation, to purchase or sell (depending on whether the option is a call or a put) the underlying bond for a specific price (the strike price) on or before the option's expiration date.
For example, let's say you purchase a price-based option on bonds of Intel (INTC) with a strike price of $1,010 and an expiration date of April 16th. This option would give you the right to purchase an Intel bond at a price of $1,010 on or before April 16th (the right to do this, of course, will only be valuable if Intel the bonds are trading above $1,010 per share at that point in time).
Why Does a Price-Based Option Matter?
Investors use options for two primary reasons -- to speculate and to hedge risk. However, it's important to note that in bond trading, price-based options are no longer very popular; instead, bond options tend to be yield-based.