Stewart Mink Case Scenario

CFA Level III Derivatives
#1

I just do not get the answer, if someone can elaborate more. Why would the cost of the put be lower?

Compared with the collar created from the Texmaco loan and the options described in Exhibit 2, which of the following combinations of option exercise rates will provide the lowest cost collar?

  1. 4.0% put and 6.5% call
  2. 4.0% put and 5.5% call
  3. 5.0% put and 6.5% call
    Solution

B is correct. Both the put and the call have lower exercise prices than the collar being proposed. Hence, for the same underlying, the cost of the put with an exercise of 4% (instead of 4.5%) less the premium received from writing the call at 5.5% (instead of 6%) exercise should be lower than the collar being proposed. Mink pays less for the 4% put and receives more for writing the 5.5% call.

#2

Review options: If u have a stock priced at 4.5, whats more expensive? Put at 4.5(right to sell it at $4.5) or put at 4 (right to sell it at $4)

if you have a stock price at 4.5, whats more expensive? Call at 5.5 (right to buy the stock at $5.5 regardless how high it goes up) or call at 6 (right to buy it at $6)

buying a put costs you money, selling a call puts money in your pocket.