37 lines
1.9 KiB
Plaintext
37 lines
1.9 KiB
Plaintext
58 • The Intelligent Option Investor
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Usually, our convention is to shade a gain of exposure in green, but
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in the case of an ITM option, we will represent the range of exposure with
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intrinsic value in orange. This will remind us that if the stock falls from its
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present price of $50, we stand to lose the intrinsic value for which we have
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already paid.
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Notice also that our (two-tone) range of exposure completely over -
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laps with the BSM probability cone. Recalling that each upper and lower
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line of the cone represents about a 16 percent chance of going higher or
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lower, respectively, we can tell that according to the option market, this
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stock has a little better than an 84 percent chance of trading for $40 or
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above in one year’s time.
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2
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Again, the pricing used in this example is made up, but if we take a
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look at option prices in the market today and redo our earlier table to in-
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clude this ITM option, we will get the following:
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Strike Price ($)
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Strike–Stock
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Price Ratio (%) Call Price ($)
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Call Price as a Percent
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of Stock Price
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70 140 $0.25 0.5
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60 120 $1.15 2.3
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50 100 $4.15 8.3
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40 80 10.85 21.7
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Again, it might seem confounding that anyone would want to use the
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ITM strategy as part of their investment plan. After all, you end up paying
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much more and being exposed to losses if the stock price drops. I ask you
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to suspend your disbelief until we go into more detail regarding option
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investment strategies in Part III of this book. For now, the important points
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are (1) to understand the difference between time and intrinsic value,
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(2) to see how ITM options are priced, and (3) to understand our convention
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for diagramming ITM options.
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From these diagrams and examples it is clear that moving the range
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of exposure further and further into the BSM probability cone will increase
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the price of the option. However, this is not the only case in which options
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will change price. Every moment that time passes, changes can occur to |