So, I think the way to think about this is what would your claim be if the firm that wrote the option / foward / swap went bankrupt tomorrow. That amount is your credit risk to that firm.
It is the option price, yes…. I don’t quite understand that though since technically the guy who sold it to you would only owe the diff between the strike and the market price, but hey, whatever.
But don’t forget the time value of the option. Presumably the option has a higher value than its intrinsic value because of time value, so if the option writer seller goes bankrupt, you’re losing out on not just the difference between the strike/market, but also the potential for further gains if this difference widened in the future. The seller owes you money for that extra potential.
given you are long the call option - if the option is in the money - the seller has to give you the underlying.
But given the underlying is at a much higher price in the market - seller can renege on the deal, not give the underlying to you, and you have to go to the market to buy it at the market price.
Max loss on call is the price paid. Theoritically, max payoff is infinite. The credit risk is bound to the value of the position and not to the price paid. As time passes value of the position keeps changing and credit risk varies accordingly.
I guess the credit risk would be $0 (since the option is out of the money) and the potential credit risk is $8.50? I didn’t realive there was a distinction between credit risk and potential credit risk, though.
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So, I think the way to think about this is what would your claim be if the firm that wrote the option / foward / swap went bankrupt tomorrow. That amount is your credit risk to that firm.
It is the option price, yes…. I don’t quite understand that though since technically the guy who sold it to you would only owe the diff between the strike and the market price, but hey, whatever.
But don’t forget the time value of the option. Presumably the option has a higher value than its intrinsic value because of time value, so if the option writer seller goes bankrupt, you’re losing out on not just the difference between the strike/market, but also the potential for further gains if this difference widened in the future. The seller owes you money for that extra potential.
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the amount at risk is the value of the thing which they told you was $8.50.
given you are long the call option - if the option is in the money - the seller has to give you the underlying.
But given the underlying is at a much higher price in the market - seller can renege on the deal, not give the underlying to you, and you have to go to the market to buy it at the market price.
CP
Max loss on call is the price paid. Theoritically, max payoff is infinite. The credit risk is bound to the value of the position and not to the price paid. As time passes value of the position keeps changing and credit risk varies accordingly.
Studying With
$8.50 is the present value of the potential credit risk.
Here is another questions confused me.
Q: An options buyer buys an american call option @ $8.50 (strike price: $30, stock price: $25). What’s the credit risk? Any potential credit risk?
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I guess the credit risk would be $0 (since the option is out of the money) and the potential credit risk is $8.50? I didn’t realive there was a distinction between credit risk and potential credit risk, though.
current risk would be zero since out of the money
potential credit risk for buyer of option would be infinity since the price of the stock could go to infinity
potential credit risk to seller is zero - he already received his premium
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