In the fourth part of our ‘Easy-Language’ series, we return to the ‘Leverage Products’ category to explore a structured product that works as a clever “anti-shock” portfolio mechanism.
This exact strategy was deployed highly successfully in the context of the early 2000s Tech-Burst: using warrants (a long-term option exposure) on short-term interest rates to cross-hedge equity risk.
While trading screens look identical, the Libor to SOFR transition fundamentally altered the US rates market behavior in three ways
Back in 1999, the underlying instrument was the Eurodollar future. Today, following the global phase-out of USD Libor in June 2023, the market has transitioned to Secured Overnight Financing Rate (SOFR) futures. For institutional traders managing short-term interest rate (STIR) risk, the direct successor is the Three-Month SOFR futures (SR3) contract.
While the Chicago Mercantile Exchange (CME) purposefully designed SOFR futures to maintain the mathematical mechanics of Eurodollar contracts, the underlying benchmark fundamentally changes the nature of the risk being managed.
Eurodollar versus SOFR futures
| Feature | Eurodollar Futures (GE - Retired) | Three-Month SOFR Futures (SR3 - Active) |
| Underlying rate | 3-Month USD LIBOR | Secured Overnight Financing Rate (SOFR) |
| Rate concept | Unsecured interbank borrowing estimate (included bank credit risk) | Transaction-based Treasury repo rate (nearly risk-free) |
| Observation | Forward-looking (rate was set at the start of the 3-month period) | Backward-looking (compounded daily in-arrears over the quarter) |
| Pricing convention | IMM Index (100 - R) | IMM Index (100 - R) |
| Basis Point Value | $25 per contract | $25 per contract |
| Notional equivalent | $1 million | Approximated to $1 million |
Source: Evolids Finance
Key structural shifts for market practitioners
While trading screens look identical, the Libor to SOFR transition fundamentally altered the US rates market behavior in three ways:
The In-Arrears shift: Libor was a forward-looking term rate, meaning traders knew their final settlement rate on day one. SOFR futures settle based on the daily overnight rate compounded in-arrears across the entire 3-month period, meaning the mathematical final rate is only known at the very end of the contract term.
Removal of the credit premium: Eurodollars reflected the rate at which banks lent to each other on an unsecured basis, meaning they naturally baked in a bank's credit risk premium during financial stress. SOFR is backed by over US$3 trillion in daily US Treasury repo transactions, making it a virtually risk-free benchmark.
Micro-volatility: legacy Eurodollar curves were historically static between the Federal Open Market Committee (FOMC) meetings. In contrast, overnight SOFR experiences daily micro-fluctuations (typically around 1 basis point per day) driven by immediate repo market supply and demand.
What does the current curve look like?
Based on Chicago Mercantile Exchange (CME) data as of the 31 August 2026, We are currently experiencing a humped yield curve: rates rise steadily into late 2027 before dipping slightly in 2028. The directly implied rates from the futures traded at the CME are (just a snapshot).
| Future | Quote | Implied three-Month SOFR Futures (SR3) |
| SR3U6 (“U” stands for September and “6” for 2026) | 96.135 | 3.87% |
| SR3Z6 (December 2026) | 95.925 | 4.08% |
| SR3H7 (March 2027) | 95.81 | 4.19% |
| SR3Z7 (December 2027) | 95.805 | 4.20% |
| SR3H8 (March 2028) | 95.84 | 4.16% |
| SR3M8 (June 2028) | 95.855 | 4.15% |
Source: Evolids Finance
The current curve is still “viable”: while not as steep as in the late 1990s, the current yield curve still favors bets on sharp interest rate cuts. The strategy would only be negatively impacted if the curve was declining (inverted).
Using a nearly risk-free benchmark makes the pricing analysis much easier by stripping out credit risk, though other rate benchmarks that include credit risk could still be used as alternatives
Use case: a warrant on the 3-month SOFR future
Because liquidity in long-dated American-style SOFR options dries up quickly, a structured product is the ideal solution for a broader range of investors. The strategy relies on a cross-hedge: if global equities crash, central banks (especially the US Federal Reserve) are expected to aggressively slash short-term interest rates to stimulate the economy through expansionary monetary policy – the FED did it reliably in the past decades. Moreover, the US central bank is unlikely to move interest rates erratically, which provides directional stability to these policy shifts.
Such an option would typically expire in two to three years, depending on the investor’s estimated timeline for a stock market crash. The strike price would represent a significantly lower short-term interest rate, meaning the option is deeply out-of-the-money at issuance, with a correspondingly low delta.
For example, during the dot-com bubble burst in the early 2000s, former Fed Chair Alan Greenspan reduced interest rates sharply, and similar active warrants offered cost-effective protection.
If the 3-month SOFR future is the underlying asset, and the investor aims to profit when short-term interest rates drop sharply—meaning the price (100 – short-term interest rate) rises—a call warrant is the appropriate instrument.
| The European call warrant on (100 – short-term interest rate) parameters for illustration purposes (own model) |
| 3-month SOFR future in two years: 95.74 => 100 - 95.74 = 4.26 |
| 1 future contract for which 1% interest represents 2’500 USD |
| K (strike): 97.00 (an implied 3% rate) <= in case of extreme stress, a (close to) 0% interest rate policy is something we estimate as likely |
| Volatility: 13% |
| Risk-free rate: 4.40% |
| Option | Value at t = 0 | Price in USD at t = 1 year with no change | Price in USD at t = 1 year with a 1% point increase in the future (so a 1% SOFR future decrease) |
| Two years European call option on 1 future contract in USD | 17.76 | 1.24 | 160.54 |
| Delta | 2.28% | 0.29% | 24.06% |
| Delta if +1 basis point (95.73) in USD | -0.57 | -0.07 | -6.02 |
| Gamma if +1 basis point (95.73) in USD | 0.02 | 0 | 0.18 |
| Vega if +1 volatility point in USD | 8.16 | 0.96 | 25.34 |
Source: Evolids Finance
This breakdown illustrates exactly why the warrant works so well as disaster insurance. The investor pays a small premium for the protection. If the crisis never materialises and rates remain stable, the premium decays rapidly. But if equities crash and the FED slashes rates, the warrant sharply increases in value.
In Part 5 of this series, we will unpack the “Capital Protection” category, showing investors how to construct a hard floor against maximum portfolio drawdowns.
| This article is based on data and analysis provided by the SRP Greeks product. Find out more about SRP Greeks here |
Image: Adobe Stock
Disclaimer: This content is not intended as a solicitation or an offer; it is provided solely for informational purposes to professional investors.The information presented herein has been prepared with great care; however, errors may still occur.