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in question alecto co (pilot 2012) – collar hedge…. can you please explain how to determine whether to exercise the option or no when the interest rates increase or decrease ?
Thank you 🙂
Since we are borrowing, we have bought a put option.
This gives us the right to sell a future at a fixed price.
If at the start of the loan, the futures price is lower than the exercise price then we will exercise (we would buy the future at the lower price, immediately sell at the higher price, and therefore make a gain).
If at the start of the loan, the futures price is higher than the exercise price, then there would be no point in exercising (it would mean buying at a higher price and lessing at a lower price, which would make a loss).
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