option risk exercise, selling, current, investor

NakedPuts

Dealer sells call option on stock for $35 to investor. The option is worth $46, as quoted in the market. Determine the amount of risk of a credit loss and which party bears this risk.

Answer is All credit risk is borne by investor. The current value of the amount at risk is the market price of $46.

CFA Vol 5 pg 256

Next example assumes European Option with underlying selling at $96 and call option purchased expiring in 6 months. Call option has an exercise price of $101 and sells for $6.

Holder of call option bears credit risk. Current value of the potential credit risk is $6.

CFA vol 5 pg 288 # 17


Why does the amount at risk in the American style option appear to be the full current excercise price of the option and the European style option appears to net the the difference and say only $6 is at risk?

zwjy

Being worth 46 will mean the underlying is at 35 + 46. The option can be struck at any time so if in the money, option cost = underlying - strike.

Hope this helps

Unforseen

SkipE99 Wrote:
-------------------------------------------------------
> ok so the 46 in the top example is NOT the current
> price of the stock?? you're saying the stock went
> from $35 and is currently valued at 35+46 = $81,
> making the option be $46 in-the-money?
>
> is it just the amount by which the option is
> in-the-money?
>
> seems like a large jump for an example to go from
> 35 to 81.

Nah, it does happen, believe me! ;-) If it says option is worth 46 that is the amount it's in the money for an American option (as you can strike it straightaway - otherwise there'd be an arb)

canadiananalyst

if anyone remembers or has any other questions testing this please post.

skycfa

46 is the option price