Question

a.         How many option and stock positions are involved in a zero-cost covered collar?

b.         State whether each option/stock position is long or short.

c.         Explain why the strategy is called a zero-cost.

Answer 1

a]

A zero-cost covered collar involves three positions :

• a position in the underlying stock
• a put option
• a call option

b]

• a position in the underlying stock - long
• a put option - long
• a call option - short

c]

It is zero-cost because the premium paid for buying the put option equals the premium received from selling the short option. Thus, the cost of the collar is zero