30 lines
1.5 KiB
Plaintext
30 lines
1.5 KiB
Plaintext
The Intelligent Investor’s Guide to Option Pricing • 73
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With this happy news story, our call options went from nearly
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worthless to worth quite a bit—the increase in volatility amplified the
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rising stock price and allowed us to profit from changes to two drivers of
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option pricing.
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There is an important follow-up to this happy story that is well worth
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keeping in the back of your mind when you are thinking about investing
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in possible takeover targets using options. That is, our BSM cone widened
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a great deal when the announcement was made because the market be-
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lieved that there might be a higher counteroffer or that the deal would fall
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through. If instead the announcement from DuPont was that it had made
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a friendly approach to the ABC board of directors and that its offer had
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already been accepted, uncertainty surrounding the future of ABC would
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fall to zero (i.e., the market would know that barring any antitrust con-
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cerns, DuPont would close on this deal when it said it would). In this case,
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implied volatility would simply fall away, and the call option’s value would
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become the intrinsic value (in other words, there is no potential or time
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value left in the option). The situation would look like this:
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20
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30
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40 Stock Price
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50
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60
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70
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Agricultural Boron Co. (ABC)
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80
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GREEN
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We would still make $5 worth of intrinsic value on an invested base
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that must have been very small (let’s say $0.50 or so), but were the situation
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to remain uncertain, we would make much more. |