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I am not familiar enough with the theories of option pricing to understand how negative option prices are possible. I found two research papers indicating that negative option prices are indeed possible for callable US treasury bonds:

Can someone explain why negative option prices are possible for callable US treasury bonds?

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  • $\begingroup$ Interesting. But FWIW all USTR bonds nowadays are not callable. $\endgroup$ – noob2 May 4 at 10:35
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    $\begingroup$ An actual option with an independent existence cannot have a negative price. But we are talking here about 'embedded options' that are part of another security (in this case a USTR bond) and cannot be separated from their parent. Their price is not quoted in the marketplace but is found by a calculation. The problem is that this calculation comes up with a negative number. It is more an ANOMALY IN BOND PRICING than a fact about options. The bond pricing takes other considerations into account that completely overwhelm the embedded optionality and make the calculation come out the way it does. $\endgroup$ – noob2 May 4 at 13:46
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    $\begingroup$ It shows the Embedded Option approach to security valuation does not always work.Because there could be another component of price which we have forgotten to include. $\endgroup$ – noob2 May 4 at 13:47

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