33 lines
2.0 KiB
Plaintext
33 lines
2.0 KiB
Plaintext
50 • The Intelligent Option Investor
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In terms of how this chapter fits in with the goal of being an
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intelligent option investor, it is in this chapter that we start overlaying
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the range of exposure introduced in Chapter 1 with the implied stock
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price range given by the BSM cone that was introduced in Chapter 2.
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This perspective will allow us to get a sense of how expensive it will
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be to gain exposure to a given range or, conversely, to see how much
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we are likely to be able to generate in revenue by accepting exposure
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to that range. Understanding the value of a given range of exposure as
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perceived by the marketplace will allow us to determine what option
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strategy will be best to use after we determine our own intelligent
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valuation range for a stock.
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Jargon introduced in this chapter is as follows:
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Strike–stock price ratio Volatility (Vol)
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Time value Forward volatility
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Intrinsic value Implied volatility
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Tenor Statistical volatility
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Time decay Historical volatility
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How Option Prices are Determined
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In Chapter 1, we saw what options looked like from the perspective of
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ranges of exposure. One of the takeaways of that chapter was how flexible
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options are in comparison with stocks. Thinking about it a moment, it is
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clear that the flexibility of options must be a valuable thing. What would
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it be worth to you to only gain upside to a stock without having to worry
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about losing capital as a result of a stock price decline?
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The BSM, the principles of which we discussed in detail in Chapter 2,
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was intended to answer this question precisely—“What is the fair value of
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an option?” Let us think about option prices in the same sort of probabilis-
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tic sense that we now know the BSM is using.
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First, let’s assume that we want to gain exposure to the upside poten-
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tial of a $50 stock by buying a call option with a strike price of $70 and a
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time to expiration of 365 days. Here is the risk-return profile of this option
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position merged with the image of the BSM cone: |