Rho(ρ) is a term that defines the relationship between the price sensitivity of an option and the rate of its interest levels. A trader can earn or lose by one percent with fluctuation in interest rates. When there is price fluctuation then the percentage rate of interest may vary.
The rates tend to increase; it will observe a downfall in value and vice versa.
The value of rho can be negative or positive depending on the situation i.e. whether it is call or put, long-term or short-term. A Rho of positive value can be used for long call options and short put options as the value is positively associated with the fluctuations in the interest rates. Whereas short call options and long put options have a negative value of Rho. In this scenario, the price of options has a negative connection with the amount of interest.
Rho in Options Greek-
The rate of interest has a crucial impact on deciding the value of rho. They play a major role in helping the greek options and have a greater impact on long-term options over ones with short tenure. When the interest rates rise the call options also go higher similarly when the put options notice a downfall then the interest rate is comparatively low as of call options.
This leads to positive rho of call options and put options with negative rho.
Greek options are used in options trading for the calculation of the elements which are directly or indirectly related to the price of an options contract. Rho is the least used option amongst the five Greek options namely delta, gamma, theta, and vega. Implied Volatility helps us to estimate the upcoming fluctuations in the value of an underlying asset.
How to calculate Rho?
Rho is nothing but the change in the value of an options price to the one percent change in the rate of interest. When the interest rates change by 1%, the value of rho is calculated accordingly based on its previous position.
Though it is said that there are a few complications in the calculation of Rho, many people still do it manually. It is measured with the changes in U.S. Treasury Bill risk-free interest rates to the options price.
Now, what is the risk-free rate of interest?
Its meaning is as simple as the name suggests. The term ‘risk-free rate’ means with no risk involved in the interest rates.
Trading by Using Rho-
There is a simple concept one should keep in mind while dealing with this Greek option; whenever the price of a particular asset goes up which is being held for a longer period results in higher sensitivity with changing interest rates having an extreme value of Rho.
It encounters the rise in value as the duration of expiration of that contract comes nearer. Usually, traders don't prefer to use Rho as they have other options available to them like delta and vega. They find it a little complicated as compared to using other options.
As mentioned earlier, positive Rho can be used for long call options and short put options. Just to clear your doubts let me help you with an illustration:
Suppose the current value of Rho is 0.35 and the price is Rs. 2/- and the interest rate increases from 3% to 4% for long call options then the rise in interest rate by 1% will affect the value of this option resulting in a change of 2.35 options price. Addition of rho of 0.35 into the current market price.
Three Conditions in case of Rho options-
It is the situation where the strike price of that option is lower than that of its spot price for put options and call options whose spot price is more than its strike price. In this case, the value of rho remains low.
When the spot and strike price of an underlying asset remains the same. This would increase the value of that particular asset if call and put options are equal at the same time. Rho tends to rise in the money option.
With the call option, the strike price is lower than its spot price and in the contrast for a put option the strike price is higher than the spot price then in-the-money option pertains to a greater value of options rho.
Describing rho in the Greeks options states the relationship between change in the price of an option to that change in interest rate. Rho can be positive or negative in the value. It describes the option’s price sensitivity to that of interest rates. Usually, traders rarely prefer to use Rho in options trading.