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q60 of bpp revision kit,collar rate calculation
why put option at 4% not exercised when its high interest rate compared to june future price 3.98%??
In borrowing cases ,we buy put option high interest rate (lowest strike price ) sell call low interest rate (highest strike price)
You will know from my lectures that a put option at 4% will actually have a price of 96 (100 – 4). So they have the right to sell futures at 96.00.
The futures price that corresponds to 3.98% is 96.02 (100 – 3.98).
Exercising the option would mean selling at 96.00 and immediately buying futures at 96.02, which would obviously be silly because it would make a loss. Therefore they will not exercise the option.
Have you watched my lectures on interest rate risk management?
Yup i have seen. I know how future work but not collar option. we are buying put option at lower strike price and sell call at higher strike price -this is what happens in borrowing
(reference to Q65 ) what I didnt understand is when its compared with future price buying put option is exercised and selling call is not. ? :/We bought the put option and so we have the right to sell the futures at 95.50. Since the futures price is 95.44, we exercise the option – we buy futures at 95.44 and immediately sell them at 95.50 and make a profit.
We sold the call option, and so it is not us who have the right to exercise – it is the person who bought it from us who has the right (and we have to pay them any profit if they choose to exercise). They have the right to buy futures at 96.00. Since the futures price is only 95.44 they will not exercise the option.
My article on collars will help you:
https://opentuition.com/articles/p4/interest-rate-collars/Wow this bit of explanation was very helpful.Much more clarity than the link. Thank you 🙂
when we sell call we receive premium and we buy put we pay premium .This is the case of borrowing .what about case of lending ?? We buy call and sell put ! isn’t ? so how the premium work ? just the reverse way?
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