Why does it equal the stock price at inception? Is there a more intuitive way to understand the concept?
B.E. always will be initial price + put premium (you are long) - Call premium (you are short) for zero cost collar put premium = call premium hence the initial price is the break even… but if you work out an example, each time that will give the break even…
Thank you, 3rd & Long. Can I look at it the following way? The breakeven of a collar combines that of a protective put and covered call, initial S + P and initial S - C, respectively. When P and C cancel each other out, the breakeven simply equals initial S. But even if P and C don’t offset each other, since a collar is meant to “lock in” the value of the underlying in a certain range, the point where you incur no loss and no profit should be your initial S. Am I getting this right?
You’re describing a “Zero-Cost Collar”. A collar is where you buy a put and sell a call. The concept behind this is that you use the premium you receive from the call to pay for the put. When it’s a zero-cost collar, the premiums offset eachother. Therefore: B.E Stock Price = Stock Price + Call Premium - Put Premium Since both the call and put premiums are equal, they cancel eachother out and you’re left with the stock price as the break-even price. PJStyles
yes, exactly…
Thank you, PJStyles and 3rd & Long. So the formula “B.E Stock Price = Stock Price + Call Premium - Put Premium” applies to any strategy involving a long position in the underlying? How about those pure option constructions (bull spread, butterfly, etc.)? Is there a universal formula? Another question on “straddle”-- I have seen different formulae for calculating the maximum profit on the downside. Should it be X - C - P or S(t) - X - C - P?
Max profit on Downside would be if the Stock went to 0, so its going to be teh Strike price minus premium
Or maybe S(t) - X - C - P calculates the max profit on the upside, and since S(t) can be a very large number, this is just another way of saying “unlimited upside”. The max profit on the downside is indeed X - C - P. Do I sound right?