Zero Cost Collar
Collar product is a structured product which is done generaly for hedging purposes. Instead of doing a simple forward contract hedger has a flexibility to buy/sell a foreign currency from a price range. The price range allows the hedger to speculate the market according to his market view rather than fixing the price in forward. Two price level forms the range and hedger knows that at the expiry date if the spot price is above the upper band level then the foreign currency transaction will be from the upper band level and if the spot price is below the lower band level then the foreign currency transaction will be from the lower band level.
For example a hedger who has a short position at USD/TRY parity in a two month period makes the Collar product to hedge his fx exposure. The hedger must buy USD and sell TRY at the expiry date in order to hedge the short position on USD/TRY. When Collar product is used for such a hedging need, the upper band level will be at a higher level than the forward price and the lower band level will be at a lower level than the forward price. When spot price is greater than the upper band level at the expiry date hedger will buy USD/TRY from the upper band level which is at a advantageous level according to spot price. When spot price is lower than the upper band level at the expiry date hedger will buy USD/TRY from the lower band level which is at a disadvantageous level according to spot price.
In fact hedger buys a Call option with the strike price of upper band level and sells a put option with the strike price of lower band level. The premiums of the both options will be equal to each other and hedger does not receive or pay any premium for the structure.
Applications:
Collar product can be suitable for the hedgers who want to hedge their foreign currency exposure but also want to apply their view about future price of the underlying currency. Some of the institutions use the worst case level in their budgets. If the market moves to up for a buyer than the upper band at collar will be their worst case level for hedging.
Advantages
-
If price of the underlying currency pair
moves inline with the side of the product (If collar is used to buy, a move to
the upside in the market is an example of such a move) then hedger makes the
foreign currency transaction with a better rate than the spot rate at the
expiry date.
-
Hedger has the flexiblity to speculate the
market in a price range according to his views.
Disadvantages
-
If the price of the underlying asset moves
against the side of the product hedger may do the foreign currency transaction
at a worse rate than the spot price.
Financial Asset : USD/TRY
Position at maturity :
USD Long
AMount : USD 1,000,000
Spot Rate : 1.5500
Forward Rate
:
1.5580
Collar Upper Band Level :
1.6100
Collar Lower Band Level : 1.5300
Tenor :
30 days
When the above informations are input to pricing screen of Derivative Engines the real time market price of the Collar will be quoted. Price of the structure are quoted by considering the real time market bid / ask spreads.
Below the payoff chart of the above example can be seen.
Below you can find the payoff graphs of the option buyer and the option seller.
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