Una nota stonata x i graficisti: C'e' un gap aperto a 1.593
I
f a stock has strong long-term potential, but in the short-term has high down-side risk then a collar can be considered. Investors will also consider a collar strategy if a stock they are long in has recently appreciated significantly. To protect these unrealized gains a collar may be used. The use of a collar strategy is also used in
mergers and acquisitions. In a stock deal, a collar can be used to ensure that a potential depreciation of the acquirers stock does not lead to a situation where they must pay much more in diluted shares.
Collar Option Strategy – Worked Example
Let us now look at an example that involves creating a collar. Say you are holding a
long position on an asset that has just recently
appreciated to a price of $100. You are unsure about the price stability in the near-term future and want to utilize a collar strategy. You buy a
put option with a
strike price of $90 at a premium of $5. You also sell a
call option for $5 with a strike price of $110.
What is your payoff if the price of the asset falls to $80?
- The call option you’ve sold will not be exercised by the buyer and you will end with a payoff of $5.
- The put option you’ve bought for $5 will be exercised with a strike price of $90 meaning a payoff of $5.
- The underlying asset will be worth $80 meaning a loss of $20.
The
protective put option you’ve purchased reduced the losses experienced from a drop in the price of the underlying asset. In total your net loss will be:
$5 + $5 – $20 = -$10.
Rather than experiencing the full loss of $80 – $100 = -$20, you have ended with a net loss of only $10.
What is your payoff if the price of the
asset increases to $105?
- The call option you’ve sold for $5 will not be exercised since the underlying asset price is still below the strike price. You will end with a payoff of $5.
- The put option you’ve bought will not be exercised since the underlying price is above the strike price. You will realize a net loss of $5.
- The underlying will be worth $105, meaning a net gain of $5.
The out of the money
call and put were both not exercised. Selling the call option covered the cost of buying the put option so the payoff and loss from the two transactions canceled each other out. In total, your net payoff will be:
$5 – $5 + $5 = $5.
It is the same payoff from just holding the underlying asset: $105 – $100 = $5
What is your payoff if the price of the asset increases to $115?
- The call option you’ve sold for $5 will be exercised at a strike price of $110. The payoff will be $0.
- The put option you’ve bought for $5 will not be exercised. The loss from the transaction will be -$5.
- The underlying asset will be worth $115, meaning a gain of $15,
In this scenario, you would end up with a net payoff of
$0 – $5 + $15 = $10.
It is less than if you had just held the underlying
asset: $115 – $100 = $15. In this scenario, the collar is limiting the upside potential of the underlying asset.
In the scenarios above, the
call option you’ve sold completely covers the cost of buying the
put option. It is called a zero-cost collar. Below is an illustration of the collar position:
Here, we can see that the loss is capped if the price of the underlying asset falls below $90. Similarly, if the price of the underlying asset rises above $110, the payoff is also capped. To further illustrate this, let’s look at two more scenarios.
What would the payoff be if the asset dropped in price to $0?
- The call option you’ve sold for $5 would not be exercised and the payoff would be $5.
- The put option you’ve bought for $5 would be exercised at a strike price of $90. The payoff would be $90 – $5 = $85.
- The underlying asset’s fallen from $100 to $0, resulting in a loss of $100.
The net payoff to you would be
$5 + $85 – $100 = -$10.
It is the same payoff when the asset fell to a price of $80. We see that the
protective put is capping the losses experienced from a fall in the underlying asset.
What would the payoff be if the asset rose in price to $200?
- The call option you’ve sold for $5 would be exercised and the payoff would be $5 – $90 = -$85.
- The put option you’ve bought for $5 would not be exercised. The loss from this transaction would be -$5.
- The underlying asset’s risen from $100 to $200, resulting in a gain of $100.
The net payoff to you would be
-$85 – $5 + $100 = $10.
It is the same payoff when the price increased to $115. Here, we can see how the collar position limited the upside potential of the underlying asset.
