Exporter Weighing a Zero-Cost Collar Against a Firm Board Floor
Nandini Agro Exporters expects USD 1,500,000 from a European buyer in four months. The buyer has a history of trimming volumes, and treasury puts the chance of the shipment falling to USD 1,125,000 (a 25% cut) at about one in four. The board has set a hard minimum net realisation of Rs 83.50 per USD on this contract and separately wants some participation if the rupee weakens further. Market data: spot 83.20; four-month forward 83.75; four-month USD put struck at 83.50 at a premium of Rs 1.35; four-month USD call struck at 84.30 at a premium of Rs 1.35. The bank has quoted a zero-cost structure of buying the 83.50 put and selling the 84.30 call, sized to USD 1,500,000. Nandini has no other USD flows and reports under Ind AS 109.
1. Build a net-realisation table for the outright forward and for the zero-cost collar at expiry spots of 82.00, 84.00 and 85.50. Which meets the Rs 83.50 board floor?
Read the worked answer
Outright forward: 1,500,000 x 83.75 = Rs 12,56,25,000; realisation is Rs 83.75 at every spot.
Zero-cost collar (buy 83.50 put, sell 84.30 call, nil net premium):
| Spot at expiry | Put | Call | Net realisation (Rs/USD) |
|---|---|---|---|
| 82.00 | pays 1.50 | lapses | 83.50 |
| 84.00 | lapses | lapses | 84.00 |
| 85.50 | lapses | assigned, pay 1.20 | 84.30 |
The collar's floor is exactly 83.50 and its cap is 84.30. Both structures meet the board floor, but the collar only just does - one paise of slippage in execution, brokerage or a different fixing and it breaches. The forward gives a flat 83.75, which is 25 paise above the floor with no execution risk, but forfeits everything above 83.75. On the numbers the forward is the safer floor; the collar buys upside of at most 55 paise (84.30 vs 83.75) in exchange for a floor 25 paise lower.
2. Assume the buyer cuts the shipment to USD 1,125,000 and spot reaches 86.50. Quantify the problem with the collar as quoted and recommend a fix.
Read the worked answer
The collar was sized to USD 1,500,000 but only USD 1,125,000 arrives, leaving USD 375,000 of written calls unbacked. At 86.50 the calls are in the money by 2.20 per USD, so the naked slice loses 2.20 x 375,000 = Rs 8,25,000, payable in cash, on top of a premium of nil. That is precisely the 'no net written options' risk that exporter hedging policies exist to prevent.
Fix: size the written call to the minimum probable receipt, not the maximum. Buy the 83.50 put on USD 1,500,000 (or at least on the full expected receipt) and sell the 84.30 call on only USD 1,125,000. The residual USD 375,000 of receivable can be covered with a forward at 83.75 or left with a small bought put. Alternatively, use a participating forward where the unhedged portion is never written.
Also check hedge documentation: a structure whose notional changes when the forecast changes is likely to fail prospective effectiveness testing, so the accounting hedge may unwind even if the economics look tolerable.
3. The board asks why it should pay Rs 20.25 lakh of premium for a bought put instead of accepting the collar. What is the honest answer?
Read the worked answer
The bought 83.50 put alone costs 1.35 x 1,500,000 = Rs 20,25,000, about 1.62% of the rupee notional, and it establishes a floor of 83.50 - 1.35 = 82.15, which is below the board's Rs 83.50 minimum. So the honest comparison is not 'free collar versus paid put'. To hit an 83.50 floor with a bought option alone, you need a higher strike and therefore a bigger premium; to hit it with the collar you sell the upside above 84.30 and accept quantity risk.
The real trade-off is: the collar transfers the cost of protection into a cap and into a contingent liability if volumes fall; the bought put transfers it into a certain cash outflow of Rs 20.25 lakh that is known today and cannot blow up. Under Ind AS 109, only the bought option's time value can be deferred as a cost of hedging; the written call's mark-to-market runs through profit or loss. For a board that has set a hard floor and dislikes surprises, the paid put, sized to the minimum probable receipt, is usually the more defensible choice.