Yield-based option refers to an option contract whose underlying asset is a fixed-income security, such as bonds or notes, and its value is based on the yield of that asset. The yield-based option provides the option holder the right but not the obligation to buy or sell the underlying fixed-income security at a specific yield or interest rate, known as the strike yield, on or before the expiration date of the option.

The strike yield of the yield-based option is the most important factor that determines the option's value. If the yield of the underlying fixed-income security moves above the strike yield, the option becomes more valuable because the holder can exercise the option to buy the security at a lower yield. Conversely, if the yield drops below the strike yield, the option's value decreases as it becomes less likely to be exercised. The option premium is the cost of buying or selling the yield-based option, and it is affected by various factors, such as the interest rate environment, the creditworthiness of the issuer of the underlying security, and the time to expiration of the option.

Investors use yield-based options to manage their interest rate risk exposure or to take advantage of anticipated changes in interest rates. For example, if an investor expects interest rates to rise, they may purchase a yield-based put option to protect against the loss in value of their fixed-income securities. On the other hand, if an investor anticipates a decline in interest rates, they may purchase a yield-based call option to profit from the potential increase in value of their fixed-income securities. Yield-based options are commonly used by institutional investors, such as banks, insurance companies, and pension funds, to manage their fixed-income portfolios.