35 lines
2.4 KiB
Plaintext
35 lines
2.4 KiB
Plaintext
610 Part V: Index Options and Futures
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The first thing one should do is to convert the striking price into an equivalent
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price for the underlying index, so that he can see where the higher striking price is
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in relation to the index price. In this example, the higher striking price when stated
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in terms of the structured product is 2.5 times the base price. So the higher striking
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price, in index terms, would be 2.5 times the striking price, or 375:
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Index call price = ( Call price / Base price) x Striking price
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= (25 I 10) X 150
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= 375
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Hence, if the Internet index rose above 375, the call feature would be "in effect"
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(i.e., the written call would be in-the-money). The value at which we can expect the
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structured product to trade, at maturity, would be equal to the base price plus the
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value of the bull spread with strikes of 10 and 25.
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Valuing the Bull Spread. Just as the single-strike structured products have
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an imbedded call option in them, whose cost can be inferred, so do double-strike
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structured products. The same line of analysis leads to the following:
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"Theoretical" cash value = 10 + Value of bull spread - Cost of carry
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Cost of carry refers to the cost of carry of the base price (10 in this example).
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By using an option model and employing knowledge of bull spreads, one can
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calculate a theoretical value for the structured product at any time during its life.
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Moreover, one can decide whether it is cheap or expensive - factors that would lead
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to a decision as to whether or not to buy.
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Example: Suppose that the Internet index is trading at a price of 210. What price can
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we expect the structured product to be trading at? The answer depends on how
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much time has passed. Let's assume that two years have passed since the inception
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of the structured product (so there are still five years of life remaining in the option).
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With the Internet index at 210, it is 40% above the structured product's lower
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striking price of 150. Thus, the equivalent price for the structured product would be
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14. Another way to compute this would be to use the cash value formula:
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Cash value= 10 x (210 / 150) = 14
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Now, we could use the Black-Scholes (or some other) model to evaluate the two
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calls - one with a striking price of 10 and the other with a striking price of 25. Using
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a volatility estimate of 50%, and assuming the underlying is at 14, the two calls are
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roughly valued as follows:
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Underlying price: 14 |