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Dear sir
About the collar, I don’t understand why there is a loss on exercise 95,000 when exercise the sell puts option. I expected it is a gain because the calculation which I have used is:
50 contracts x 1,000,000 x ((96.50-95.74)/400) = 95,000 gain
Thank you.
They buy call options, not put options, because they are depositing money and therefore need to protect against a fall in interest rates.
With an exercise price of 96.50, and if the future price is 95.74, exercising the option would mean buying futures at 96.50 and selling them at 95.74. Therefore they will not exercise the options.
Have you watched my free lectures on interest rate risk management?
Dear sir
Thank you for your reply.
I understand when hedging by options, Massie buy call as they deposit the money. And I have not got any mistake in this part as I have watched the lectures.
However, if using a collar, they buy calls at 97.00 and sell put at 96.50. If interest rates increase to 4.1% (future price 95.74), they will not exercise call but will exercise put. (I understand why they do not exercise call options)
The answer states that it is a loss 95,000 on exercising the put, but I do not understand why there is a loss.Thank you.
Maybe I got the reason.
The benefit of exercising sell options is opposite to buy options.
The objective of exercising buy options is to gain on exercise but need to pay premium.
But sell options is to receive the premium but will loss on exercise.Hope my understanding is correct.
Your understanding is correct except for one important thing.
When we buy a call option, it is our choice as to whether or not to exercise the option and so we will only exercise if there is a profit.
When we sell a put, it is not our company who decides whether to exercise it or not. It is the person who bought the put option who decides. The buyer will exercise if they are going to make a profit, and if they do exercise it then we have to pay out – we make a loss because we have to pay the buyer.
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