Book 5 P 281 Q17 they say that the credi risk of an OTM option is the premium. The premium is paid on contract initiation therefore all your have there is settlement risk. Why is the premium included in the credit risk? The POTENTIAL CURRENT credit risk should be 0 no?
It is a European Option. Long pays 6$ Premium
Underlying is 96, Strike is 101 - so it is OTM - so no Current Credit Risk.
But if the price increases per expectations - and if the Short fails to deliver - Long faces Potential Credit Risk. And the current value of the Potential Credit Risk = Premium that he has paid of 6$.
I guess the current value of the potential credit risk is the amount you pay for the option.
if he’s already paid the premium on initiation then why is there credit risk associated with it? that’s what I’m trying to understand.
credit risk of an option is the value of the option. yes he already paid the premium, but the assumption is that in a fair market, that premium correctly represents option value + time value.
so if theoretically, on the day he bought it for 6 dollars, he wanted to “value it”, the value placed on the option would be 6 dollars. something like ~ 0 dollars for option value and ~ 6 dollars for time value.
since he is to receive this amount he bears the credit risk.
okay thanks makes sense.