What are STIR Futures & Options: Definition, Price Quotation & Example

What are Futures?

Futures are a type of financial instrument used in the derivative segment. It is a standardised derivative contract between two parties to buy or sell an asset at a predetermined price and quantity on a specified date in the future on an exchange. 

What are STIR futures?

The acronym STIR stands for Short Term Interest Rate. STIR Futures are a type of financial instrument used in the derivative segment based on a specific short term interest rate. It is a standardised derivative contract between two parties to buy or sell at a predetermined price and quantity on a specified date in the future on an exchange. 

Price quotation of STIR futures

Price quotation of STIR Future = 100 - the rate of interest.

This depicts an inverse relationship between the direction in which the underlying interest rate is expected to move and the value of the contract.

Let's understand this better with the help of an example. Assume that the rate of interest is 2.45%.

Price quotation of STIR Future = 100 - 2.45 = 97.55.

So the price quotation of this STIR futures contract is 97.55. 

Squaringq off of STIR futures

• Long position

If an investor has taken a long position by buying a STIR future contract, this will be considered as an open position. When the investor takes a corresponding short position on the aforementioned STIR future contract, the position will be closed and thus squared off.

• Short position

If an investor has taken a short position by selling a STIR future contract, this will be considered as an open position. When the investor takes a corresponding long position on the aforementioned STIR future contract, the position will be closed and thus squared off.

STIR futures products available for trade:

• ICE SONIA Futures

The ICE SONIA Futures are based on the average Sterling Overnight Index Average (SONIA). The SONIA rate is published by the Bank of England. 

• ICE SOFR Futures

The 1-month ICE SOFR futures contracts and 3-month ICE SOFR futures contracts are based on the Secured Overnight Financing Rate (SOFR). It is published daily by the Federal Reserve bank of New York.

• Three Month Euribor Future

The Three Month Euribor Future is based on the EMMI EURIBOR rate for three month deposits.The European Money Markets Institute (EMMI) publishes the Euribor rate. Euribor refers to the Euro InterBank Offered Rate i.e. the rate at which European banks lend money to each other. 

• Three Month Saron Index Futures

The Three Month Saron Index Futures are based on the average Swiss Average Rate Overnight (SARON) rate. 

• Eurodollars

Eurodollars refer to a forward looking 3-month ICE LIBOR rate at contract expiration. ICE LIBOR refers to the Intercontinental Exchange London Interbank Offered Rate.

• Fed Fund futures

Fed fund futures are one-month futures based on the average daily effective Fed Funds rate (EFFR). It is calculated and reported by the Federal Reserve Bank of New York.

• Others

Hong Kong Interbank Offered Rate (HIBOR), Tokyo Interbank Offered Rate (TIBOR), and other financial centers have their own short term interest rate derivatives available for trade.

What are options?

Options are a type of financial instrument used in the derivative segment. It is a standardised derivatives contract that enables the owner of the instrument the right to buy or sell the underlying asset at a predetermined price and quantity on a specified date in the future.The right to buy is without any obligation. The seller of the option is, however, obligated to buy or sell, should the buyer exercise his or her right. 

What are STIR options?

The acronym STIR stands for Short Term Interest Rate. STIR options are a type of financial instrument used in the derivative segment based on a specific STIR future contract. It is a standardised derivative contract between two parties to buy or sell at a predetermined price and quantity on a specified date in the future on an exchange. 

STIR option products available for trade:

• Options on Three Month Euribor Future

Options on Three Month Euribor Future are based on the nearest three month Euribor futures contract.

Features of STIR futures and options:

• Traded on Exchanges

STIR futures and options are traded on exchanges like the Intercontinental Exchange and the CME group.

• Cash Settlement

STIR futures and options are only cash settled.

• Duration

The duration of STIR futures and options is less than one year. Hence they are also referred to as money market instruments. 

Pros of STIR futures and options

• Hedging

STIR futures and options can be used by investors to protect themselves from adverse price fluctuations in the future as when used effectively, they can provide price stability in such instances.

• Speculation

STIR futures and options can be used by investors for speculation purposes i.e. to earn a profit from the upward or downward movement in the market.

• Monetary policy decisions by Central Banks

Based on the data of STIR futures and options trading, the Central Banks can take informed decisions that affect the monetary policy of the country. Eg. Fed fund rate.

• Liquidity and transparency

As STIR futures and options are traded on exchanges, this promotes liquidity and transparency. 

Risks associated with trading in STIR futures and options

• Interest rate risk

Interest rate risk refers to the potential loss that can be incurred by an upward or downward move in the short term interest rate. This can sometimes wipe out the entire capital deployed.

• Currency risk

If the exchange rate is affected dramatically due to external factors such as geopolitical tensions etc this alone can be responsible for incurring a loss.