Quiz - Potential Credit Risk particular, currently, believes, potential, next

jbaldyga

Tony Smith believes the price of a particular underlying, currently selling at $96, will increase substantially in the next 6 months, so he purchases a European call option expiring in 6 months. The call option has an excercise price of $101 and sells for $6.

What is the current value of potential credit risk? (Also an explanation of why if you can)

Chuckrox

Since the European Call is our of money at this point in time - the credit risk should be 0, no?

Iginla2011

oh.. Potential credit risk could be infinite?

Valores

no credit risk, LaGrandeFinale explanation is correct

bkballa

I am glad I am not the only one in the zero camp.. CFAI Reading 39, page 288, answer for problem 17.b:

"The current value of potential credit risk is the current market value of the option, which is $6. Of course, at expiration, the option is likely to be worth a different amount and could even expire out of the money"

WTF is CFAI doing here? Are they looking at this from the perspective of the other counterparty and insinuating he hasnt been paid yet and thats why his credit risk would be 6? It certainly doesnt seem there is any way Tony Smith (sounds made-up) has apotential credit risk of $6.

lcw77

I would say $6. But, that's only because there's a sample exam problem that's almost identical to this one (maybe the CFA Mock?) and they used the call premium as the potential credit risk.

Who knows, just do what the CFAI says... why question their logic, it's not consistent at times.

mar350

It's $6, because the Black–Scholes model calculates the price of European call options. The option price indicates that even though the option is currently out of money, due to time and volatility, it could potentially be in the money at expiration.

canadiananalyst

Right, but then for call buyer $6 will be price risk, not credit risk (becouse the other party doesn't have an obligation to pay $6 back).
I am finally confused...

NakedPuts00

Related question:

Given - "A call option the bank purchased from a dealer for $30. The current market price of the option is $35"

For the Banks long call option position, the most appropriate estimate of the amount of risk of a credit loss is

A. $0
B. $35
C. $30

lcai

is the stock price or the call option price $30? If the strike price is $30, then, $35 is the corect answer, but if the Q is as you stated, then, I don't know how you can get to the answer.