Financial Risk Management: Collar and Straddle Option Strategies

Financial risk management

TABLE OF CONTENTS
Section iii.........................................................................................................................................3
The collar strategy.......................................................................................................................3
Straddle strategy..........................................................................................................................4
Conclusion and recommendation....................................................................................................5
References........................................................................................................................................6

SECTION III
The option is referred to as the contract between the two parties, in which the buyer has a right to
exercise the option, and the seller has an obligation to perform the option. In the financial
derivatives, there are various option strategies available by which the risk can be minimized and
the return maximized (Johannes, 2017). This part of the study is based on the collar option
strategy and straddle Strategy of the option. The study also covers of the practical application of
cited strategies and the benefits and shortcomings of the same is also explained.
The collar strategy
The collar option strategy is constructed by the purchasing the put option and simultaneously by
selling the call option. The put option is purchased at a price i.e. out of the money; therefore in
case of the reduction in prices, the investor can protect himself by exercising the put option ( Lee,
Lee, and Lee, 2016). Further selling the call option generates the income to the investor in terms
of the premium received by the buyer of the position. This strategy is adopted by the investor if
he predicts in the coming years the prices of the underlying stock will not increase.
The trader buy them out of money put option and get protected from the large reduction in the
prices of the underlying asset. The price paid for buying the put option is deducted from the
amount received by selling the call option.
Further, in this option strategy, the investor can protect himself from the large losses. In this
strategy, the loss is to the extent to the amount of premium paid for buying the put option. The
maximum profit to the investor is strike price of per option deducted from the purchase price per
share of the stock and the cost of the option. Further, the maximum loss to the investor is the
purchase price of the underlying stock deducted from strike price of the put option and cost of
the option.
Let’s assume that the current purchase price of the Equity Index Markets Options Expiring Dec
18 stock is $ 94 per share. The investor is long 1000 shares of the Equity index at a price of $
100 per share. Due to the volatility in the market, the investor wants to protect his position
through the caller strategy.