# Option : Price, value, payoff

Dear All:

Coming to the derivatives, I am so confused about these terms: Price , Value , and payoff.

Could you please give an example of each one in terms of Option or Swap.

Thank you so much for your time

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Price and Value are the same thing. Both mean how much money you would pay for the derivative right now. Payoff means what the derivative pays at the maturity date or payment dates.

As an example, take a vanilla call option on some stock.

The Payoff at maturity is max[0, (Final Stock Price - Strike)].

The Price, might be, say $5. That’s how much it would cost to buy the option today.

“The aliens on Mars cloned Hillary Clinton.” - Turd Furgeson

Hmm, not sure about this. The book says:

“Some confusion from that terminology may still arise, in that an option could trade in the market for an amount that differs from its value.”

(Institute 84)

Institute, CFA.

2016 CFA Level I Volume 6 Derivatives and Alternative Investments. CFA Institute, 07/2015. VitalBook file.The citation provided is a guideline. Please check each citation for accuracy before use.

But then it also says:

“Pricing the option is the same as assigning its value.”

(Institute 84)

Institute, CFA.

2016 CFA Level I Volume 6 Derivatives and Alternative Investments. CFA Institute, 07/2015. VitalBook file.The citation provided is a guideline. Please check each citation for accuracy before use.

So not sure.

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I believe pricing the option is different than as assigning it’s value, because value at initiation should be 0. The price will be what you pay for it, but the value will change as the swap moves throughout it’s life.

Studying With

Price and value are most definitely

the same thing.notPrice and value are

equalif the asset isfairly priced; they arenot equalif the asset is eitheroverpricedorunderpriced.The price of a derivative depends on the type of derivative:

prices: the fixed rates on the two currencies.twoprice: there is no fixed rate.noprice: there is no fixed rate.noThe value of a derivative is the present value of what you will receive less the present value of what you will pay, each discounted at the risk-free rate.

Simplify the complicated side; don't complify the simplicated side.

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More pondering:

“Consider the purchase of a call option at the price c

_{0}. The value at expiration, c_{T}, is c_{T}= max(0,S_{T}– X).”(Institute 123)

Institute, CFA.

2016 CFA Level I Volume 6 Derivatives and Alternative Investments. CFA Institute, 07/2015. VitalBook file.The citation provided is a guideline. Please check each citation for accuracy before use.

The book is using little c to mean both price and value! Very confusing.

Anyway, based on what Magician stated:

Currently my interpretation of options is:

If the option is fairly priced, as you pointed out, the price and value will equal. So for a call costing say $5, the underlying must be trading at for example $65 and the exercise price of this option must be $60. Options priced differently to $5 or with strike prices different from what I stated will be mispriced/over(under)valued. I’ve never traded options but I’m assuming that at time t=0, you can buy options with the same strike at different prices and also at the same price with different strikes? This is based on the table in Reading 60 under the heading “2. Option Strategies for Equity Portfolios” As time goes by, we reach c

_{T}, at which point we definitely can be observing the value of the option based on the difference between the prevailing underlying’s price and the option’s strike. However, what would the price of this option be at t=T then?P.S. Would be much clearer if the book didn’t mishmash the two terms. Another example of this happening:

We obtain the profit for the covered call by computing the change in the value of the position, V

_{T}– V_{0}. First recognize that V_{0}, the value of the position at the start of the contract, is the initial value of the underlying minus the call premium. We are long the underlying and short the call, so we must subtract the call premium that was received from the sale of the call. The initial investment in the position is what we pay for the underlying less what we receive for the call. Hence, V_{0}= S_{0}– c_{0}. The profit is thus(Institute 130)

2016 CFA Level I Volume 6 Derivatives and Alternative Investments. CFA Institute, 07/2015. VitalBook file.The citation provided is a guideline. Please check each citation for accuracy before use.

However at the start of the chapter, it clearly states:

S

_{0}, S_{T}= price of the underlying at time 0 and time T(Institute 120)

2016 CFA Level I Volume 6 Derivatives and Alternative Investments. CFA Institute, 07/2015. VitalBook file.The citation provided is a guideline. Please check each citation for accuracy before use.

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They’re assuming that the option is fairly priced. It would be nice if they mentioned that somewhere. (However, in their defense, they probably don’t realize that they’re making that assumption.)

At expiration the option has no time value, so its value is its intrinsic value:

_{T}− X, 0)_{T}, 0)Simplify the complicated side; don't complify the simplicated side.

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Ah that makes sense!

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I love it when I finally make sense.

(It happens so rarely.)

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams

http://financialexamhelp123.com/