36 lines
1.5 KiB
Plaintext
36 lines
1.5 KiB
Plaintext
52 • The Intelligent Option Investor
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Thus, if you thought that you would win $1 for each successful invest-
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ment you made, you might only be willing to pay $0.04 to play the game. In
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this case, you would be wagering $0.04 twenty times in the hope of making
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$1 once—paying $0.80 total to net $0.20 for a (probabilistic) 25 percent
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return.
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Now how much would you be willing to bet if the perceived chance
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of success was not 1 in 20 but rather 1 in 5? With options, we can increase
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the chance of success simply by altering the range of exposure. Let’s try this
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now by moving the strike price down to $60:
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5/18/2012 5/20/2013 249 499 749
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20
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30
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40
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50
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60
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70
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80
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90
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100
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999
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Advanced Building Corp. (ABC)
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Date/Day Count
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Stock Price
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GREEN
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After moving the strike price down, one corner of the range of
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exposure we have gained falls within the BSM probability cone. This option
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will be significantly more expensive than the $70 strike option because the
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perceived probability of the stock moving into this range is material.
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If we say that the chance of this call option paying its owner $1 is
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1 in 5 rather than 1 in 20 (the range of exposure is within the 16 percent
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line, so we’re estimating it as a 20 percent chance—1 in 5, in other words),
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we should be willing to pay more to make this investment. If we expected
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to win $1 for every five tries, we should be willing to spend $0.16 per bet.
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Here we would again expect to pay $0.80 in total to net $0.20, and again
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our expected percentage return would be 25 percent. |