Can't agree with book in credit risk part

CFA Level III
#1

Hi guys,

I have confusion when reading credit risk part, which may be a easier task for someone of you.

Original statement : “A dealer has sold a call option on a stock for $35 to an investor. The option is currently worth $46, as quoted in the market. Determine the amount at risk of a credit loss and state which party currently bears the risk.”

Answer:“All of the credit risk is borne by the investor (the owner of the call), because he will look to the dealer (the seller) for the payoff if the owner exercises the option. The current value of the amount at risk is the market price of $46.”

I cannot agree with the author. The rising option price can be solely on increasing volatility of underlying price. The dealer may own nothing to the call holder if the stock price is still smaller than strike price under the contract. Am I correct?

Can someone share relevant thoughts in this case? Thanks.

#2

We’re talking about credit risk here, and in whom it lies, and not the reasoning behind the change in the call price or what would happen in any particular one scenario in a hypothetical situation. It is clear that the credit risk lies with the owner of the option, as if he executes it, the dealer would owe him, and the dealer might not be creditworthy at that point.

#3

We are talking about potential credit risks here not an actual one and therefore the answer is correct.

#4

thanks a lot

#5

I appreciate your comments.

#6

I’m glad to help.