as an executive, you received stock options As an executive, you received stock

Question

as an executive, you received stock options As an executive, you received stock options that you recently exercised. However, you cannot legally sell the stock for the next six months. Currently the stock is selling for $38.25. A call to buy the stock at $40 is selling for $3.38 and a put to sell the stock at $35 is selling for $1.94. How could you use a collar to reduce your risk of loss from a decline in the price of the stock? Verify that the collar does achieve its objective. Option strategics are not limited to covered puts and calls, protective puts and calls, straddles, bull and bear spreads, and collars. Other strategics include the "strip," the "strap," and the "butterfly spread." The following problems illustrate these strategies. (You could also construct strips, straps, and butterflies using puts.)

Explanation / Answer

A caller strategy used by following way:

Hold the underlying asset

Buy out of the money Put option (Strike price 35, premium 1.94)

Sell out of the call option (Strike price 40, premium 3.38)

So maximum loss from collar would be:

Maximum loss = stock price – strike price of put – net premium received

                                = 38.25 – 35 – (3.38 -1.94)

                                = 1.81

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