Imagine that you are holding 5,000 shares of stock, currently selling at $40 per
ID: 2794421 • Letter: I
Question
Imagine that you are holding 5,000 shares of stock, currently selling at $40 per share. You are ready to sell the shares but would prefer to put off the sale until next year for 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 of $45 are selling at $2, and January puts with a strike price of $35 are selling at $3 Assume that you hedge the entire 5,000 shares of stock. a. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $30 Stock price b. What will be the value of your portfolio in January (net of the proceeds from the options) if the stock price ends up at $40? Stock priceExplanation / Answer
Please note that Collar is a option to reduce the losses from down side . In this case persion is holding share in present i.e long position so they want to sell its share in future date. So he purchase PUT Option(Write to sell) and sell CALL Option(Obligation to Sell ). In the case of PUT he will paid premium and for CALL he will received premium.
Hence, Net outflow of Premium is as follows:
Premium paid for PUT Option = No. of Shares * Premium per Put = 5000*$3 = $15000
Less:-Premium Received from CALL Option = No. of Shares * Premium per Call = 5000*$2 = ($10000.)
Net Amount Paid = $ 5000
Case 1. If Stock Price ends up at $30, Then Put option is exercised as market value of Share is less than the strike price but call will not be exercised.
So, Sale proceeds from Put Option = No. of Shares*Strike price of Put = 5000*$35 = $ 175000
Less : Net Amount Paid for Premium = ($ 5000 )
Value of Portfolio in January = $ 170000
Case 2. If stock price ends up at $40, then Put Option will not be exercised as market price is more than Strike price of put and Call is also not exercised as Strike price of Call is more than market price .
So, Sale proceeds from Market = No. of Share * Price of each share in Market = 5000*$40 = $200000
Less : Net Amount Paid for Premium = ($ 5000 )
Value of Portfolio in January = $195000