You have a collar option. How does volatility impact the value of this instrument? If this is an American collar option, when will you decide to exercise the option?
Depending on the moneyness of the option, volatility could affect the option’s value differently. If the option is currently out of the money with respect to the lower strike price, then an increased volatility will help increase the value of the option. If the stock price is currently between the two strike prices, then the impact of volatility is a little more ambiguous. If the stock price is closer to the upper bound then an increased level of volatility could take the value down. The reverse is true for if the stock price is closer to the lower strike price.
Finally, if the stock price is above the higher strike price, then an increased volatility will serve to decrease the value of this collar because the value has reached the cap and any volatility in the stock can only take the option away from this cap. If this is an American collar, then of course an investor would choose to exercise this option when it has reached the cap; no point holding onto an option that cannot appreciate further in value. Otherwise, if the stock price is currently in between the strike prices, then the exercise decision will be more difficult to determine but as we all know it will be drive by the underlying dividend level.