Glenn, RE: Zero Cash Collars
as per WSJ 2/2/00
It is clear from the article that a zero cash collar is simply the sale of an out of the money covered call, with the proceeds used to purchase an out of the money put, so no net premium is either paid or received. One offsets the other.
In this case, when the stock was about 25, Volpe limited his downside risk to 22.37 in exchange for limiting his upside potential to 30.07.
That's the easy part. It is the "prepaid variable forward" that is incomprehensible from the author's description.
Ruth Simon explains:
"His broker gave him $2.162
million, or $21.62 per share, against 100,000 Kemet shares. When the
agreement expires next August, Mr. Volpe will pay the broker a sum
based on Kemet's closing price and a price range set when the contract
was established.
If that hedge expires with Kemet trading at $51.1875, Mr. Volpe will have
to hand over to his broker roughly $4.75 million-equivalent to nearly $2.6
million in interest on what he received from his broker just a year earlier.
Mr. Volpe's true cost will be lower, however, because he earned a profit
investing the money he was advanced."
She earlier tells us that this hedge was also done when the stock was in the mid 20s.
It sounds to me like Mr. Volpe's broker got a very good deal indeed or Ruth got her math wrong.
How does this sound to you? Lend me your stock, which is currently worth $25. I pay you $21.62. If your stock goes up to $51.1875, you pay me back $47.5.
I can only imagine what you have to pay me if the stock does not do quite so well.
Bizarro!
If anyone gets it, please explain.
Sam |
