How to Use Options Rho

Out of the five main Greeks that are typically used by options traders, Rho is the least important. It's also the least used, and in fact most traders pay little, if any, attention to it. It measures how the price of an option will theoretically change as interest rates change.

Its lesser importance is largely because interest rates don't commonly change significantly and, when they do, the effect on the price of options is relatively small. Nonetheless, it's worth having at least a basic understanding of what rho value is and how it's relevant to options trading and so below we provide a brief explanation on the subject.

Characteristics of Rho

Rho can be either positive or negative. An option with a positive rho value will, in theory, increase in price when interest rates rise and will decrease in price when interest rates fall – assuming that all other factors remain equal.

The price of an option with a rho value of .01, for example, will increase by $.01 for each percentage point interest rates go up, and decrease by $.01 for each percentage point interest rates go down. It's the other way around for options with a negative rho value; they go up in price when interest rates fall and go down in price when interest rates rise. Calls have positive rho values, while puts have negative rho values.

The value of Rho will usually be higher when there is a long time until expiration, and will decrease over time as the expiration date approaches. This is largely because there is less extrinsic value in an option as it gets nearer expiration date, and because of this interest rates will have very little effect on the price. Even when the rho value is at its highest, with a long time until expiration, the theoretical effect it has on price is usually quite small anyway.

Putting Rho to Use

Rho is really not that significant to the vast majority of options trading strategies. Really, the only time it's particularly important to consider the rho value of an option is when interest rates are changing dramatically.

Interest rates do have some impact on the cost of calls, and this is largely to do with the carrying cost of owning stocks and other financial instruments. The carrying cost of owning such instruments is based on the money required to buy them. The money required may have to be borrowed, in which case there would an interest cost associated. Even if the money required was available and on hand, there's still a notional cost because that money could be invested into an interest bearing deposit account. As such, the higher the interest rates, the higher the carrying cost would be.

Buying calls on a financial instrument is cheaper than buying the financial instrument itself, but elements of the carrying cost are built into the price of calls. As a result of this fact, when interest rates go up, the cost of calls must go up as the increased carrying cost of owning the relevant underlying security are reflected in the price.

Also, calls become more attractive to investors when interest rates are high, because the cost savings between buying calls and buying the relevant underlying security becomes more relevant as there is a greater benefit for having cash in an interest bearing account. This leads to a higher demand for calls which can also increase the price.

In summary, options Rho isn't a subject you need to worry too much about. If you are using the Greeks, then the delta, gamma, theta, and vega value are far more important and far more likely to have an impact on what trades you make and when.