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Spreads and Collars

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Brief note on spreads and collars
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  11/8/2014 Spreads and Collars - Srikanth Perinkulamhttp://srikanthperinkulam.com/tap/spreads-collars 1/12 avgaon Spreads and Collars Posted on April 8, 2014  by Srikanth PerinkulamPut-Call Parity Equation:Spread: Position consisting of only calls or only puts. Srikanth Perinkulam Beyond all athings Actuarial Ca󰁬󰁬   [   K        ,  T      ]–    P󰁵󰁴    [   K        ,  T      ]=     PV       [−     K        ]=–    K       F       0,  T      F       0,  T     P       󰁥    −     󰁲T       11/8/2014 Spreads and Collars - Srikanth Perinkulamhttp://srikanthperinkulam.com/tap/spreads-collars 2/12 Bull Spread: 1. Long call [K1,T] + Short call [K2,T]2. Long put [K1,T] + Short put [K2,T]3. Perform well when the price of the underlying asset goes up Bear Spread: 1. Short call [K1,T] + Long call [K2,T]2. Short put [K1,T] + Long Put [K2,T]3. Perform well when the price of the underlying asset goes down Box Spread: 1. Synthetic Long forward + Synthetic short forward2. Strategy guarantees a cash flow in the future3. A means of borrowing or lending moneyOption market-makers have low transaction costs and can sell box spreads which isequivalent to borrowing They’re alternatives to buying a bond4. Costly but no stock price risk 5. Payoff – IRRESPECTIVE of the underlying asset Ratio Spread: 1. m Long call [K1,T] + n Short call [K2,T] [SAME underlying asset]2. m Long put [K1,T] + n Short put [K2, T] Collars:Purchase Collar: [AM/OM]  Long Put [K1,T] + [OM] Short Call [K2,T] , K2> K1Collar width = Diff. of strike prices =–    K        2    K        1     11/8/2014 Spreads and Collars - Srikanth Perinkulamhttp://srikanthperinkulam.com/tap/spreads-collars 3/12 Written Collar: [AM]  Short Put [K1,T]  [OM] Long Call [K2,T] , K2> K1 Zero cost collar: 1. Pick the desired put strike below or at the forward price2. Find a strike above the forward price such that a call has the same premium Collared Stock: 1. This position entails buying the stock, buying a put, and selling a call.2. It is an insured position because we own the asset and buy a put.3. The collared stock looks like a bull spread; however, it arises from a different set of transactions. The bull spread is created by buying one option and selling another. The collaredstock begins with a position in the underlying asset that is coupled with a collar. Straddles: Non directional speculations – Holder does not care whether the stock price goes up or down, butonly how much it moves.Long call [K1,T] + Long put [K1,T]Advantage: Benefits from stock price movement in either directionDisadvantage: High premium Bet on High volatility – Investor believes volatility is HIGHER than the market’s assessmentCost of straddle will be greater when markets perception is that volatility is greater Written Straddle: Short call [K1,T] + Short put [K1,T] Bet on low volatility -  Investor believes volatility is LOWER than the market’s assessment  11/8/2014 Spreads and Collars - Srikanth Perinkulamhttp://srikanthperinkulam.com/tap/spreads-collars 4/12 Highly risky since a large change in the stock price leads to potentially unlimited loss Strangle: Investor holds a position in both a call and a put with different strike prices but with the samematurity and underlying asset. [OM] Long Call [K1,T] + [OM] Long Put [K2,T]Reduced premium as compared to the Straddle This option strategy is profitable only if there are large movements in the price of the underlyingasset.Use this strategy when you speculate a large price movement in the near future but unsure whichway the movement will be. Butterfly Spread: Written straddle [K2,T] + Strangle [K1,T and K3,T] Related

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