Converting Short-Term Rate Futures Quotes for Option Volatility
Summary
The question concerns implied volatility for options on eurodollar and other short-term interest rate futures. The accepted response explains that these contracts are quoted as prices tied inversely to interest rates, so the futures price and strike can be translated into rate terms using 100 minus the quoted value, divided by 100. It also says to account for the corresponding call and put reversal when making this transformation.
The response notes that these options have American exercise and that Bloomberg supplies a lognormal volatility model, while some market participants quote normal volatility in basis points. Other respondents disagree about the needed transformations, arguing for using futures prices and strikes directly and checking the implied volatility by repricing the option. The material therefore captures a convention-sensitive implementation issue rather than resolving every model choice. Practitioners should match the inputs, option type, exercise treatment, and volatility convention to the specific contract and pricing model; the discussion does not provide a full calculation procedure or reconcile the competing answers.
Key ideas
- Short-term interest rate futures are commonly quoted as 100 minus an interest rate, so price-to-rate conversion affects option inputs.
- Transforming from futures-price terms to rate terms also reverses call and put interpretations.
- American exercise applies to these options, though the response describes its practical impact as limited in the cases discussed.
- Lognormal and normal volatility conventions are both used, so the selected model must match the market quote convention.
- Repricing an option with the calculated implied volatility can help check that the implementation is internally consistent.
Tags
Full text
# Parameters for pricing option on EDF # Parameters for pricing option on EDF Ladies and Gents, Im writing a quick routine to calculate implied vols for options on EUR$ futures with Bloomberg data. My question concerns the part where I have all my inputs and am ready to pass them to my implied vol function. Assume we have the following market quotes (example ticker: EDK1C 98.750 Comdty): Strike = 98.750 Underlying Spot = 99.7050 Option Price = 0.9550 When passing these to my function, do I convert the Underlying spot and strike to S = (100 - Underlying Spot)/100 and K = (100 - Strike)/100 respectively and use the market option price as is so our implied vol method is some function IV = f(S,K,Option Price,...) OR convert the option price to oP = 100 - (Option Price)*100 and leave the spot and strike such that our implied vol method is some function IV = f(Strike ,Underlying Spot,oP,...) ??? The latter has yielded a rational result but I would love some feedback. Thanks. ## Answer by David Reiner (score 2, accepted) https://quant.stackexchange.com/a/1441 Eurodollar options (and STIR options in general) are options on the RATE, so you have to transform the strike and underlying futures prices to yields as you mentioned (100-x)/100 AND you have to switch puts and calls. Also remember they are American exercise, although that's not very important these days. The volatilities are on the rates (log-relative returns). In Bloomberg, you have to use a lognormal model and no other models are provided. But many practitioners use other models and quote the 'normal' (basis point) vols instead of the Black-Scholes vols. ## Answer by glyphard (score 1) https://quant.stackexchange.com/a/1156 If it is option on future, you don't need the spot price at all. use the unaltered units for S and K, and you should get results for IV that make sense. If you think they don't make sense, just plug your IV result back in and verify that you get the option price back correctly. ## Answer by G__ (score 1) https://quant.stackexchange.com/a/1298 I'm not sure where the (100 - X)/100 pattern is coming from. Implied volatility is defined on top of the Black-Scholes value for an option, which I understood to multiply a decaying function of the dividend and interest-free rates with the current spot and strike... In any case, I've always seen it expressed in terms of straight prices, no normalization necessary.
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