Imagine that you are holding 6,700 shares of stock, currently selling at $55 per
ID: 2743606 • Letter: I
Question
Imagine that you are holding 6,700 shares of stock, currently selling at $55 per share. You are ready to sell the shares but would prefer to put off the sale until next year due to tax reasons. If you continue to hold the shares until January, however, you face the risk that the stock will drop in value before year-end. You decide to use a collar to limit downside risk without laying out a good deal of additional funds. January call options with a strike price of $60 are selling at $4, and January puts with a strike price of $50 are selling at $6. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $41, $55, $61? What will the value of your portfolio be if you simply continued to hold the shares?
Stock Price
Imagine that you are holding 6,700 shares of stock, currently selling at $55 per share. You are ready to sell the shares but would prefer to put off the sale until next year due to tax reasons. If you continue to hold the shares until January, however, you face the risk that the stock will drop in value before year-end. You decide to use a collar to limit downside risk without laying out a good deal of additional funds. January call options with a strike price of $60 are selling at $4, and January puts with a strike price of $50 are selling at $6. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $41, $55, $61? What will the value of your portfolio be if you simply continued to hold the shares?
Explanation / Answer
The collar involves buy a put and writing a call option
The receivables from writing a call = 6700*4
Cost of put = 6700*6
Net outflow = 6700 (6-4) = 13,400
1. When share price = 41
Value of shares= 41*6700 = 274,700
The call expires worthless
Payoff from put = (50-41)*6700 = 60,300
Portfolio value = portfolio value of shares + option payoff = 274,700 + 60,300 = 335,000
2. When price = 55
Both the call and put expires worthless
value of portfolio is only the value of shares held = 6700*55 = 368,500
3. When price = 61
Put expires worthless
call value = (60-61)*6700 = -6700 (it is an outflow)
Value of shares = 6700*61 = 6700*61 = 408,700
Value of portfolio = 408,700 - 6700 = 402,000
Case: when no collar is used
portfolio value = no of shares * price
1. 6700*41 = 274,700
2.6700*55 = 368,500
3.6700*61 = 408,700