Dear All:
If I long a put and short a call on LIBOR, does it mean I recieve that I receive fixed and pay floating or receive floating and pay fixed? so confused.
Do you have any tips to remember it
Thank you so much for your time
Basically remember this - it will take us two options to replicate the Forward rate agreement.
One to mimic the loss and the other to mimic the gains.
Also remember:
A payer/ receiver are all in “with respect to” the guy on the fixed side.
In a fixed rate payer swap - the guy pays fixed rate and receives floating rate payments.
&
In a fixed rate receiver swap - the guy pays floating rate and receives fixed rate payments.
Long a Call & short a put - replicates a fixed rate payer in a swap.
Short a call & long a put - replicates a fixed rate receiver in a swap.
Question: Why would one take either of the positions above?
- If the guy - Believes the interest rates will go up, so wants to benefit by buying a call for gains.
Long a call(buyer of a call) = expect to profit from the upward movement in interest rates.
short a put(seller of put) = selling a put, will lead to a loss if the interest rates goes down.( which he thinks will not happen and thus wants to gain from the premium received by selling a put )
- If the guy - Believes the interest rates will go down, so wants to benefit by buying a put for gains.
Long a put (buying a put) = Expect to profit from the downward movement in interest rates.
Short a call(seller of call) = selling a call, will lead to a loss if the interest rates goes up.(which he thinks will not happen and thus wants to gain from the premium received by selling a call ).
Thank you so much your time.
Best regards
Wow this is great summary! I was struggling for 10 minutes to figure out how to get this straight. This really helped!
Same!!! Thanks a lot!! What a great answer!
Note that in ganeshrpl’s explanation, the put and the call have the same strike price.
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