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Sir please explain how have they chose the three different collar combination.Thanks
Because they are depositing money, they need to buy a call option (to fix a floor / minimum) and sell a put option (to fix a cap / maximum).
Since the floor must be below the cap, they can only create a collar by choosing combinations where the strike price for the call is higher than the strike price for the put.
Thank you so much sir ,it make sense.
But just one more ,can we buy put option n sell call,as i always get confuse that since call is right to buy n put right to sell so we always buy call and sell put,please make this clear. ThanksWe usually just buy options, but you are buying either a call option (which is the right to buy a future at a fixed price) or we are buying a put option (which is the right to sell a future at a fixed price.
We only sell an option if we are creating a collar.
I have another question related to this. Why do you ADD Put premium? I thought premium is always paid.
Many thanks!
You do pay a premium when you buy an option.
However here, because they are depositing, the are buying a call option (and so paying a premium) and selling a put option (and so receiving a premium).
OK, understood.Thanks!
What about point b) ii) Estimate the maximum interest that could be received with your selected hedge. How should we approach this question? Please help me understand. Many thanks!Selling a put fixes a cap (maximum interest rate) and since they are selling a put with a strike of 95.25, this is equivalent to maximum interest of 100-95.25 = 4.75%.
The free lectures on interest rate options (together with the separate note on collars) will help you.
Hi John,
I tried to read the lecture notes of this topic interest rate collar but I am having difficulties to u derstand. can you please explain about this question of how they get call strike price and put strike price and how they calculate to get the premium.
Thank you and looking forward to hearing from you.Have you watched the lectures on options, because calculating the premium is covered in great detail in the lecture.
The collar can be created using any combination of the stroke prices available. Depending on which strike prices are chosen the cap and floor interest rates will be different.
The net premium is the difference between the premiums for the option they buy and the option they sell. As always, the premium is calculated by multiplying the table figure by the number of contracts and by the contract size, and then dividing by 400 (to get a three-monthly percent). Again you need to watch the lecture on options to really understand that.
Have you watched the lectures on options, because calculating the premium is covered in great detail in the lecture.
The collar can be created using any combination of the stroke prices available. Depending on which strike prices are chosen the cap and floor interest rates will be different.
The net premium is the difference between the premiums for the option they buy and the option they sell. As always, the premium is calculated by multiplying the table figure by the number of contracts and by the contract size, and then dividing by 400 (to get a three-monthly percent). Again you need to watch the lecture on options to really understand that.
I kinda understand how they get the numbers now sir. Thanks to ur lecture note. But I would like to know why the call price have to be greater than put strike price. Sorry if it sounds stupid.
Trader is depositing money, and so buying call options will fix a minimum interest rate (which is what they want to do if they are depositing money). In order to reduce the premium they can sell put options. This will mean that are accepting a maximum interest rate, but the benefit is that the net premium will be reduced.
The maximum interest rate will have to be more than the minimum interest rate which the why the strike prices chosen have to be that way round.Sir can you please explain as to how the interest rates of 4.25% and 4.50% were obtained?
If the strike price is 95.50, then it is equivalent to an interest rate of 100 – 95.50 = 4.50%
If the strike price is 95.75, then it is equivalent to an interest rate of 100 – 95.75 = 3.45%You really must watch the free lecture on interest rate futures (because interest rate options are options on futures).
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Dear John,
Many thanks for all your help
I am a bit confused on collars and the way calls & puts are used.
If a company is borrowing, then buying a call option on interest rates will be used as a ‘floor’ and if lending and buying a call option on interest rates futures will be used as a ‘cap’?
Also, why, if company is borrowing, impose on itself a ‘floor’ by buying a call option on the int.rate future ?
You must watch my free lectures on options, and read my article on collars (it is linked from the main P4 page.
A company borrowing may decide to create a collar (and therefore have a cap and a floor) in order to reduce the net cost of the premium). I do explain all this in the article.
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