Question

Replacing the strategy of risk free cashflow. Why not long shares, long put and short call? Again, how to decide what strategy to use?

Answer 1

The different investment strategy is listed below:

1. 1st set of Investors: The strategy of investors is to generate a risk-free return. Government bond has a sovereign guarantee and risks free cash flows. The reward will be the outcome of the risk taken.
2. 2nd set of investors is looking for a higher return, need to match with associated risk and prefer to invest in the equity. Equity investment is risky but pays off better than bonds if you long on the share whose price is expected to increases in the time domain. This is a straight forward equity investment but downside risk also remains if the stock price crashes due to some reason. Thus investor needs to protect themself from undue variation by utilizing options mechanism.
3. Thus a combination of long share, long put and the short call will develop the collar in options theory. This strategy limits the upside gains as well as downside risk. This is primarily used for the hedging but this is best used by low-risk investors who are inclined to have better return then govt bonds.

Thus, if an investor is completely risk-averse then risk-free cash flow strategy is useful but if an investor is a limited risk-taker, the investor can adopt the collar options strategy. This gives him or her the opportunity to have a better return with limited risk.