I have been reading about option adjusted duration and it feels really technical.
Can someone explain it in simple terms? I understand it relates to bond price sensitivity but the math is hard to grasp.
How does this help with trading decisions?
I got crushed - lost 40% on a bond ETF when rates spiked because I completely ignored duration risk.
Here’s how it works: higher duration = bigger price swings when rates move. Bond with 5-year duration? It’ll drop about 5% for every 1% rate increase.
Now I always check duration before jumping into any fixed income trades.
Standard duration assumes cash flows remain unchanged. Option adjusted duration considers exercised options, providing a clearer understanding of risk for callable and putable bonds.
Bonds with call options act differently when rates change. Standard duration measures price changes, but option-adjusted duration factors in those options, which can skew predictions. This metric helps predict how your bond will react to rate shifts. It’s important for managing risk in bond trading.
Regular duration shows how much a bond’s price moves when interest rates change. But callable bonds don’t play by those rules since the issuer can call them early if rates drop.
Option adjusted duration factors in that early call risk. It’s way more accurate for actual price sensitivity. Skip it and you’re trading blind on bonds with embedded options.
This video explains why effective duration beats basic duration for these bonds:
Use option adjusted duration for bonds with embedded options. Regular duration will screw you over every time.
It measures bond price sensitivity to interest rate shifts. That’s key for trading.