In chapter 12 under interest rate caps it says that the caps can be seen as a series of call options. Later on in the chapter (pg. 15) it says that the interest rate caps can be seen as a put option. I'm not understanding why that is the case. I can see how it can be a series of call options. L*delta*max(Rk-Rx). if Rk is greater than Rx, then there is a payoff otherwise there isn't a payoff. But I can't see how a cap can be a put option when describing as layoffs on zero coupon bonds. An explanation would be much appreciated. Thanks
prices and yields! Hi, This is a common problem with caps and floors. the problem revolves around that fact that a caplet can be viewed as either a call or a put depending on which underlying asset you choose. A caplet is exercised when the interest rate rises above the strike rate. this feels like a call option. And indeed early in the course we say that a cap can be viewed as a series of call options on interest rates. However, when interest rates go up, the price of a zero coupon bond goes down. So the same caplet would exercise when the PRICE of a bond falls below a preset level (determined by the strike interest rate of the caplet). So in another way, the caplet can be seen as a put option on the price of a notional bond. And a cap viewed as a series of put options on notional bonds. I hope this helps. I prefer to focus on the interest rates, and I would describe them as call options. Partly because the formula to value them is based on interest rates, so you would use the CALL option formula to value a caplet and the put option formula to value a floorlet.
