Question

Collar hedge: Using the NYMEX Crude Oil Call and Put information in the Appendix, answer the questions below.

Lauren Simkins E&P wishes to construct a collar hedging strategy. Lauren Simkins, the CEO, tells you she wants you to construct a hedge to protect the firm from declining crude oil prices for upcoming production. The CEO states that you are to buy a put option that gives crude oil price protection for a minimum of $100 per barrel. She tells you to sell an offsetting call so that your total hedging strategy costs no more than 50 cents total per barrel (i.e., total premium paid on the put minus the premium received on the call is no more than 50 cents net paid per collar). Which call and which put did you select? Pick the best collar. List the collar below and tell the total cost of the collar strategy

Answer 1

To create a collar strategy, You need to buy a put option & sell a call option. Buying a put option is simply taking a long position in Put at Exercise Price = K₁ (in your case it is $100). Similarly selling a call option is simply taking a short position in Call option at Exercise Price = K₂.

Since you require a minimum of $100 /barrel protection, You buy a Put option at Exercise Price (K₁) = $100. Suppose the price of Put option is $p.

Now you will sell the call to recover atleast $ (p - 0.5). Hence sell a call option with price (c) greater than p-0.5 and having a Excercise price(K₂) of atleast $100.

c > p-0.5 (Should be satisified)

K₂ > $100 (Should be satisified)

To get the best collar, you have to minimize cost maximizing the payoffs.

You haven't provided any numbers for actual calculation (I can't see any appendix here). For further query, please provide the Appendix.