Definition of futures contracts and STIR options

What are STIR futures and options?

STIR stands for “short-term interest rate,” and institutional traders refer to options or futures on these rates as STIR futures or STIR options. Categories of STIR derivatives include futures, options and swaps.

Key points to remember

  • Short-term interest rate derivatives (STIRs) are most often based on securities with three-month interest rates.
  • The main use of these is to hedge against interest rate risk in short term loans.
  • Buyers or call options or futures on STIR securities bet that interest rates will rise, buyers of put options bet that interest rates will fall.

Understanding STIR Futures and Options

The underlying asset of STIR futures and options is a three-month interest rate security. The two main contracts traded are the Eurodollar and Euribor, which can trade over a trillion dollars and euros on a daily basis in a fully electronic market.

The category also includes other short-term benchmarks, such as the 90-day ASX note accepted by banks in Australia and other short-term floating interest rates, such as the London Interbank Offered Rate ( LIBOR) and its equivalents in Hong Kong (HIBOR), Tokyo (TIBOR) and other financial centers. Many businesses and financial institutions use STIR contracts to hedge against borrowing or lending risk.

While speculators may find STIR trading profitable, the most common use is for hedging with option strategies such as caps, floors, and collars. Central banks could monitor STIR futures to gauge market expectations ahead of monetary policy decisions. Therefore, changes in STIR futures could be useful for those who wish to foresee this policy.

Use of futures and STIR options

Anyone who trades in the interest rate futures market has an opinion on whether the rates will rise or fall during the short term of the futures contract. As with any futures contract, the buyer thinks he can buy the contract now and profit from an increase in the price of the underlying asset when the contract expires. These futures contracts settle in cash, so the profit or loss is simply the difference between the settlement or delivery price and the purchase price. This is different from some other futures contracts, such as commodity futures, which settle with the physical delivery of the underlying asset by the seller to the buyer.

Other than specific contract sizes and minimum price fluctuations, there is very little difference between STIR futures and options and other standard futures and options. The STIR is the short-term equivalent of “long maturities” which describes only part of the yield curve, but on all markets (Eurodollars, LIBOR, etc.).

Trading in the most active STIR futures and options offers high efficiency, liquidity and transparency to hedges. This saves a company the trouble of creating hedges against complicated strategies in the over-the-counter (OTC) market and taking on the counterparty risk.

STIR contract details

Although each exchange sets its own contractual specifications, there are a few general rules. Expiration dates generally follow the International Money Market (IMM) dates of the third Wednesday in March, June, September, and December. Exceptions include Australian invoices and New Zealand invoices are notable exceptions. ASX also offers “serial” contracts which also expire on the third Wednesday of all contract months.

The price of an STIR contract is typically 100 minus a relevant three-month interest rate, therefore a rate of 2.5% gives a price of 97.50.

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