Funding an Illiquid Stock Collar When Shares Cannot Be Borrowed

Summary

The document considers a funded equity collar for a shareholder seeking cash against an existing stock position. The proposed structure combines a margin loan secured by pledged shares, a purchased put, and a written call with a nearby strike. The bank would normally hedge its option exposure by shorting the stock, which requires borrowing shares.

The central issue is that an illiquid lending market may prevent the bank from borrowing the stock, while using the pledged shares for hedging may be legally restricted. The question raises stock lending or repo arrangements as possible alternatives to the margin loan structure. It does not provide an answer, analyze the legal or operational mechanics, or compare the resulting credit and market risks. The document is useful as a description of the financing and hedge constraint, but it leaves the proposed alternatives unresolved.

Key ideas

• A funded collar can pair a secured loan with a long put and short call against an existing stock holding.
• The bank may need to borrow shares to short hedge the collar.
• An illiquid stock loan market can make that hedge difficult or impossible.
• The document asks whether a stock loan or repo could replace the margin loan structure but gives no resolution.

Tags

# How to apply a funded equity collar to illiquid stocks?


# How to apply a funded equity collar to illiquid stocks?












I investigate a specific case of the funded equity collar [1].

Let's assume that counterparty $A$ already has a stake in share $XYZ$ and wants to get funding out of it from a bank $B$, which does not want to get too much credit exposure from the resulting operation.

If I refer to this question [1], bank $B$ can offer a margin loan to counterparty $A$ which must pledge its shares $XYZ$ and buy a put option strike $k$ and sell a call strike $(k+\epsilon)$ on shares $XYZ$ (see existing question above). In that case, bank $B$ will have to delta hedge the collar by short-selling shares, which had to be borrowed earlier from a third counterparty.

However, what if the borrowing and lending market is not liquid enough, such that bank $B$ might not be able to borrow shares $XYZ$ from the market. It would then mean that delta hedging is just not possible or should be done via the shares in the pledge, which is legally forbidden a priori.

Is there an alternative to the margin loan (pledge + financing) in that particular situation of illiquid lending market? For instance, would it feasible to transform the pledge into a stock lending (GMSLA) or a repo (GMRA) without modifying the rest of the structure ?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.