Question states that the cost of a put option strategt is 2 million(High). Asks if there is alternatives to reduce the cost of hedgin by using different put options. And a disadvantage for each
They mention in the answers, Knock out put, Put spread and using puts with lower strike prices as alternatives. Then they mentioned a disadvantage for each.
I said using a cashless collar or a prepaid forward as options to reduce the COST of HEDGINg. Wasn’t mentioned in the solutions. A collar has a put option in it and I said that a disadvantage of it is, that it has limited upside gain.
Why is a collar and prepaid forward not mentioned as an optoin for hedging in the answer?
You were only supposed to use put options in your answer… I went with buy a put further out of the money, obvious drawback is less protection… And sell a put option further out of the money to make up some of premium for the put you purchased.
Yeah. Zero collar would work and it does have a put option in it. What’s frustrating is I would have lost all those marks because they want ONLY put options.
Hijacking this to ask a similiar question. Is there a reason why a put butterfly wouldn’t work here to reduce hedging costs?
It’s a concetrated position and only put options can be used. So, am I missing something about using a put butterfly?
Buy low strike put, sell two medium strike puts, buy high strike put.
I have protection to the downside with regards to my concentration position and I’d assume this would potentially reducing heding costs but that could be the wrong assumption.
A butterfly is more of a volatility play than a hedging play. The payoff for a long put fly would be maximixed if the stock ends up right at the middle strike at expiration. This would only be a good hedge if the stock ends up specifically at that strike, no higher or lower. That doesn’t sound like the definition of a good downside hedge…
If the stock fell to $0, we’d have to be compensated for our underyling becomming worthless, but our butterfly spread would not only not compensate us, it would actually lose the premiums paid.
Not sure why I didn’t put that all together myself. Can’t wait to Saturday to be over with.
I’m with you–so looking forward to this all being over!