Range Forward

Explained:

cylinder

range forward

tunnel


A range forward (also called a cylinder or tunnel) is a costless collar used to hedge a short position in an underlier. The name "range forward" is used because the hedge is used in lieu of a simple forward hedge.

Unlike the forward hedge, which locks in a specific price for the underlier, the range forward locks in a price range for the underlier. In this way, the holder participates in small moves in the underlier while being protected from larger moves. This is illustrated with payoff diagrams in Exhibit 1.
 
   

Hedging with a Range Forward
Exhibit 1

When used to hedge a short position in an underlier, a costless collar is sometimes called a range forward. It leaves exposure to modest market moves but eliminates exposure to larger moves. By comparison, hedging with a forward would eliminate all exposure.

 

Related Internal Links

forward contract A trade that is agreed to at one point in time but will take place at some later time.

futures spread A long-short futures position.

options spread Position combining two or more options in a single underlier.

put-call parity A formula that relates the price of a put to the price of a corresponding call.

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copyright © Glyn A. Holton, 1996

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