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Hi Jhon,
My understanding about collar hedge is as follows:
1. premium payable today (difference between call and put rate)
2. exercising option similar to options on futures. when the interest rate is higher in the market exercise the option, if not allow it to lapse.
3. The only thing that separate a collar hedge from options on future is we can use either of the exercise price (put or call) depending upon the rate of interest prevailing in the market at the date of settlement.
4. The confusion for me is when single strike rates given for put and call which one to use for put and which one for call. (for eg. pilot paper june-13 onwards). Would the theory work, if I consider borrow money, therefore put option and the higher exercise price(I mean lowest interest rate) to sell and lowest exercise price (higher interest rate) to buy.Is this knowledge enough for me to construct a collar hedge accurately???
ThanksI suggest you may please ignore the above question. I think I cracked the whip. Now I wanted to know how a collar hedge on deposit may work:-
An eg.
ROI- 8+2% (current)
Sell put option @ 92 –cap – premium -0.20
Buy call option @ 93- floor Premium – 0,15Effective interest to find if LIBOR increases to 9.50% and futures move to 90.20
My answer:-
Premium payable (0.05)
Actual interest 11.50
Counter party
exercise option (1.80)
(92-90.20)effective interest 9.65%
If LIBOR falls to 4.50% and futures move to 96.10
My answer:-
Premium payable (0.05)
Actual Interest 6.50
Firm will exercise
option
(96.10-93.00) 3.10Effective ROI 9.55%
It would be of great help, if you spare some time and let me know whether or not my understanding on collar hedge for deposits are adequate to answer similar questions.
I thank you in advance
At a quick look, what you are doing seems find.
You might also find the following article useful that I posted some time ago:
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