Fence (finance)

From Wikipedia, the free encyclopedia

Fence is an investment strategy that uses options to limit the range of possible returns on a financial instrument.

A fence consists of the following elements:

long position in a financial instrument (e.g. a share, index or currency)
long put (normally with a strike price close to or at the current spot price of the financial instrument)
short put (with a strike price lower than the bought put - e.g. 80% of the current spot price)
short call (with a strike price higher than the current spot price)

The expiration dates of all the options are normally the same. The call strike is normally chosen in such a way that the sum total of the three option premiums are equal to zero.

This investment strategy will ensure that the value of the investment at expiry will be between the strike price on the short call and the strike price on the long put. Thus possible gains and losses (the value of the financial instrument minus the cost of acquiring it) are confined within a specified range.

However, if the price of the financial instrument falls below the strike level of the sold put the investor will start participating in any further price declines of the financial instrument.

References

Derivatives market

Derivative (finance)

Options

Terms	Credit spread Debit spread Exercise Expiration Moneyness Open interest Pin risk Risk-free rate Strike price The Greeks Volatility

Vanilla options	Bond option Call Employee stock option Fixed income FX Option styles Put Warrants

Exotic options	Asian Barrier Binary Cliquet Compound option Forward start option Interest rate option Lookback Mountain range Rainbow option Swaption

Combinations	Collar Fence Iron butterfly Iron condor Straddle Strangle Covered call Protective put Risk reversal

Spreads	Backspread Bear spread Bull spread Box spread Butterfly spread Calendar spread Diagonal spread Ratio spread Vertical spread Intermarket Spread

Valuation	Binomial Black Black–Scholes model Finite difference Garman-Kohlhagen Put–call parity Simulation Trinomial Vanna–Volga pricing

Swaps

Forwards/Futures

Backwardation
Commodity futures
Contango
Currency future
Financial future
Forward market
Forward price
Forward rate
Index future
Interest rate future
Margin
Pricing of Forwards
Pricing of Futures
Single-stock futures

Other derivatives

Market issues

This article is issued from Wikipedia. The text is available under the Creative Commons Attribution/Share Alike; additional terms may apply for the media files.