29 lines
1.4 KiB
Plaintext
29 lines
1.4 KiB
Plaintext
The Intelligent Investor’s Guide to Option Pricing • 71
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because of the added uncertainty surrounding product liability claims.
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Here is what the situation looks like now:
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20
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25
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30
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35
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40Stock Price 45
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50
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55
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Antelope Bicycle Corp. (ABC)
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60
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GREEN
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This time we were right that ABC’s implied volatility looked too cheap, but
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because we were directionally wrong, our correct volatility prediction does us
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no good financially. The stock has fallen heavily, and even with a large increase
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in the implied volatility, our option is likely worth less than it was when we
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bought it. Also, because the option is now further OTM than it originally was,
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time decay is more pronounced. Thus, to the extent that the stock price stays at
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the new $45 level, our option’s value will slip away quickly with each passing day.
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Rise in Volatility Amplifies Accurate Directional Prediction
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These examples have shown cases in which changes in option pricing
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variables work to the investor’s disadvantage, but it turns out that changes
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can indeed work to an investor’s advantage as well. For instance, let’s say
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that we find a company—Agricultural Boron Co. (ABC)—that we think,
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because of its patented method of producing agricultural boron com-
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pounds, is relatively undervalued. We decide to buy 10 percent OTM calls
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on it. Implied volatility is sitting at around 25 percent, but our option is far
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enough OTM that it is not very expensive. |