Reading 28 - Question 5

[Galli]

Page 345 of book 5
A stock is currently trading at 80. You decide to place a collar on this stock by buying a put at the 75 strike for 3.50 and a call at the 90 strike for 3.50.
The question continues on to ask about the various profit/losses on this collar trade if the stock closes @ X price(s). The answers give a payoff that includes a long position in the underlying.
Do we always assume calls are covered if there is a short exposure on the call side? I keep reading this question over and over again and the way it’s written does not indicate the trader is long the underlying. Should we assume they are long if they enter into a collar trade?

 

[Tommy83]

I just did this question yesterday. I messed it up the same way you did. It’s not too difficult, though.
The question says, “you decide to put a collar on this stock”. The wording is a little strange but a collar, by definition, is long the underlying. It’s also (i) long a put and (ii) short a call. The fact that it says “collar” means you’re long the underlying. It’s tricky b/c they spelled it out more directly in other questions if you’re long the underlying, if I remember correctly.
A collar is basically an extention of a protective put (also long the underlying), where you also write a call to generate income to pay for the put you purchased.

 

[Galli]

Thanks Tommy for confirming.
In the actual reading they had an example of a Collar trade where the explicitly said they were also long the stock so I was a little hestitant to assume being long the stock in this question.
Does anyone know what you call an option trade where you’re short the call and long the put WITHOUT the underlying? More curious than anything

 

[ink]

Galli wrote:
Does anyone know what you call an option trade where you’re short the call and long the put WITHOUT the underlying? More curious than anything

without the underlying, max loss will go to infinite and your max gain will be strike price of the put option.
This sounds very much like the payoff of a bear split. Buy a put and sell a call in a way that their option premium cancel each other.

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