For the Interest Rate Collar with “long floor + short cap”, the payout diagram looks like a Bull Spread.
But for the Interest Rate Collar with “long cap+ short floor”, does it look like a put spread (in the currency chapter)?
Just want to confirm on this. Thank you!
Hey dududu,
That sounds right to me. The Short Floor would have a higher strike rate than the Long Cap, constructing what would have a similar payoff diagram to a put spread. If both option premiums cancel out, you would have effectively constructed a zero-cost collar.
I am now trying to wrap my head around a scenario though… lets say your are receiving floating, then you would want to purchase a floor to protect yourself. If you’re paying floating, you would want to purchase a cap to protect yourself.
But if you want to stay within two bounds, would it matter how you construct your collar? I guess my question is, When are you supposed to construct a bull collar and when do you instead construct a bear collar???.. gaaah my brain…
Here you’re also long the interest rate.
Here you’re _ not _ short the interest rate.
Hey S2000 
Just to be on the same page a cap is akin to a call (i.e. the buyer makes money when interest rates rise above the strike) a floor is akin to a put (i.e. the buyer makes money when interest rates fall below the strike) If I were to buy a put and sell a call (i.e. setup a covered call + protective put, that would be equivalent to a bull spread) Then why isn’t selling a put and buying a call (the exact reverse position), a put spread?
Mind you aren’t bear spreads and bull spreads based on buying two calls or two puts, or vice versa, hence they are called spreads… hahaha I think I’m turning myself into a pretzel…
Yes.
Yes.
That’s equivalent to a bull spread only if you also have a long position in the underlying. Note that for both a protective put and a covered call you own the underlying.
It’s only the exact reverse position if you’re also short the interest rate.
a cap is akin to a call, a floor is akin to a put. So sell a floor, buy a cap, their combine payoff diagram is
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if you combine with a long position in the underlying, it becomes a bull spread, the payoff diagram is
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Not quite.
You combine a long call and a short put with a _ short _ position in the underlying; the payoff looks like this: ¯_.
You combine a _ short _ call and a _ long _ put with a long position in the underlying to get a payoff that looks like this: _/¯.
Be careful.
Thanks a lot for your answers! Forgot the underlying again. I listed all the four situations below with and without underlying, can you just confirm on this, please? Thanks!
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a short call and a _ long _ put with a long position in the underlying to get a payoff that looks like bull spread : _/¯.
a short call and a _ long _ put without a long position in the underlying to get a payoff that looks like the inverse of put spread
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Yes, although your put spread and inverse put spread (call spread?) diagrams are wonky.
Are we required to draw diagrams? I am able to solve many of derivatives questions but I won’t to draw anything, just am using formulas. I haven’t reached any question so far with asked to draw anything. I draw as a 5 year old, lol!
You’re not required to draw diagrams.
But many people find them immensely helpful in understanding option strategies.
Thanks, S2000Magician! Didn’t know it is called Call Spread. Thanks!
I am still using my 10 year old IBM laptop which has a 12 inches screen. When I drew them at first, they looked fine until I posed the thread…
I don’t know that it’s called a call spread; that simply seemed like a reasonable name when compared to put spread.
Hey S2000, thank you very much for your help as always
You’re quite welcome.