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A bond is a contract between the bond issuer and bondholder, where the former borrows a certain amount of money for a specific maturity period in exchange for bond ownership and interest payment. The invested principal is to stay locked in for the predefined maturity period and to be returned to the investors once the bond matures. That said, provisions for exiting the contract are available and examples for the same are the call and put options.
Defining the Call Option
Bond issuers can call the bond, or in other words, buy the bond back from the bondholder before the maturity date arrives. A call notice is sent to the investor, and the bond is bought back, typically at a premium rate. Bonds that have the call option are called callable bonds. The call dates are predecided and mentioned in the bond document during the issuance.
Example
Name: SBI Callable Bonds
ISIN: INE062A08249
Maturity date: Perpetual
Coupon: 7.74%
Callable date: September 9, 2025
Why is the Call Option Exercised?
Suppose the interest rate in the market has decreased, and an existing bond offers higher interest rates to the investors. In such a situation, the bond issuers can call the bond back and reissue the bond at the new reduced rate. It will help the issuer to cut down the bond cost and interest liability.
While the option is a useful feature for bond issuers, it may not be such good news for investors. The investors will miss the chance to keep their investment untouched by the decreasing market rates and will have difficulty finding profitable reinvestment options.
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Defining the Put Option
The concept of the put option is similar to the call option, but it is different in terms of standpoints. It gives the bondholders the right to sell the bonds back to the investor. If the put option is implemented, the bond issuer must return the principal amount to the bondholder. These bonds are called puttable bonds.
Why is the Put Option Exercised?
Much like the call option, investors can decide to sell the bond and look out for better rates if they expect the market rates to increase and the value of their bond to decrease.
Example
Name: Shriram City Union Finance Ltd. Puttable Bond
ISIN: INE722A07AG5
Maturity date: May 3, 2023
Coupon: 9.25%
Puttable date: June 5, 2021
Wrapping Up!
Liquidity is important and so are the amicable options to deal with market uncertainties. The call-and-put options assist the bond issuers and holders in dealing with the fluctuating market rates and making the most profitable investment decisions.
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FAQs About What is Call Option & Put Option?
1. What are call dates?
Call dates are the preset dates on which the issuer can call the bonds.
2. What is the protection period?
The call protection period is a certain time period from the date of issuance during which a bond cannot be called by the bond issuer.
3. When should one opt for the put options?
The decision depends on the respective investor. A typical reason behind the decision to exercise the put option can be an attempt to take advantage of the increased interest rates in the market.
