39 lines
1.6 KiB
Plaintext
39 lines
1.6 KiB
Plaintext
278 • The Intelligent Option Investor
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Given what you know about the BSM, does this seem like the kind of
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situation conducive to accurate option pricing? This example certainly does
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not sound like the pricing scenario of a short-term agricultural commodity,
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after all. If this hypothetical drug company’s stock price was sitting at $50 per
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share, what is the value of the upper range the option market might be
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pricing in? Let’s assume that this stock is trading with a forward volatility of
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100 percent per year (on the day I am writing this, there are only four stocks
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with options trading at a price that implies a forward volatility of greater than
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100 percent). What price range does this 100 percent per year volatility imply,
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and can we design an option structure that would allow us to profit from a big
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move in either direction? Here is a diagram of this situation:
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5/18/2012
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-
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500
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50
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100
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150
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200
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250
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300
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350
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400
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450
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5/20/2013 249 499
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Date/Day Count
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Advanced Biotechnology Co. (ABC)
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Stock Price
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749 999
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GREEN
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GREEN
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Indeed, even boosting volatility assumptions to a very high level,
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it seems that we can still afford to gain exposure to both the upside and
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downside of this stock at a very reasonable price. Y ou can see from the pre-
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ceding diagram that both regions of exposure on the put side and the call
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side are outside the BSM cone, meaning that they will be relatively cheap.
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The options market is trying to boost the price of the options enough so
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that the calls and puts are fairly priced, but for various reasons (including
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behavioral biases), most of the time it fails miserably. |