Financial Derivatives - Multiple Option Strategies

Multiple Option Strategies Extra Credit

Option Collar Position

1. (2 pts) You wish to enter a Collar Position. This position requires two individual option positions. Describe these two positions in terms of whether they are both call options, both put options, or one of each, and then describe whether each option is purchased or sold. In addition, describe the difference in the strike price of each option, and explain why the difference in strike price is needed for this position.

Answer: This position is made by selling a call option at one strike price and using

the proceeds to purchase a put option at a lower price. Thus, the selling of the call option has the higher strike price (K1), and the purchasing of the put option has the lower strike price (K2). The difference in the strike prices of K1 and K2 is needed because the position essentially “collared” between the two strike prices. This “collared” position allows the investor to realized the exact highest (K1) and lowest (K2) dollar amounts they could potentially receive when they sell their underlying stock.

2. (2 pts) In terms of both strike prices (K1 & K2), option prices (OP1 & OP2), and the underlying asset prices (S), what is the maximum gain that can be earned from entering a Collar Position? Over what range of underlying asset prices does this maximum gain occur in terms of K1 and/or K2?

Answer: Maximum Gain = Call Strike – Stock Purchase Price – Put Premium + Call Premium

OR

Maximum Gain = K1 – S – OPPut + OPCall

3. (2 pts) In terms of both strike prices (K1 & K2), option prices (OP1 & OP2), and the underlying asset prices (S), what is the maximum loss that can be experienced from entering this position? Over what range of underlying asset prices does this maximum loss occur in terms of K1 and/or K2?

Answer: Maximum Loss = Stock Purchase Price – Put Strike + Put Premium – Call Premium

OR

Maximum Loss = S – K2 + OPPut -...