Bill Jones inherited 5,000 shares of stock priced at $45 per share. He does not want to sell the stock this year due to tax reasons, but he is concerned that the stock will drop in value before year-end. Bill wants to use a collar to ensure that he minimizes his risk and doesn't incur too much cost in deferring the gain. January call options with a strike of $50 are quoted at a cost of $2, and January puts with a $40 exercise price are quoted at a cost of $3. If Bill establishes the collar and the stock price winds up at $35 in January, Bill's net position value including the option profit or loss and the stock is ________.

Question

Quizplus · Accepted Answer

Position value = 5,000 shares × $45 share = $225,000. To establish a collar, you would need 5,000/100 = 50 options. You would buy the 50 puts at a cost of $3(100)(50) = $15,000 and write the 50 calls, earning a premium of $2(100)(50) = $10,000. The initial cost is $15,000 − $10,000 = $5,000. If the stock price in January is $35, then profit can be found as:
Profit = [Max ($0, $40 − $35) − Max ($0, $35 − $50)](100)(50) − $5,000 = $20,000
New stock value = 5,000 shares × $35 = $175,000, so Net position value = $175,000 + $20,000 = $195,000

Bill Jones Inherited 5,000 Shares of Stock Priced at $45