Credit Risk -Options

CFA Level III
#1

Experts… s2000,hm et al

“For an European option prior to expiration, the current market value of the option would be the amount at risk.(potential credit risk)” 1. What does the market value refer to ?? The payoff or the actual price of the option in the market ? 2.What will be the amount at risk at expiration ?

3.How do american options differ in this regard ?

Thanks in advance

#2

Hi,

  1. Today’s option price (think of a single number, different from the hockey-stick payoff function). Only works when you are long an option. Zero current credit risk for a sold option (in practice that is not so in case of regular margining, not in CFA curriculum).

  2. When viewed at expiry, same, except for the market value is known without pricing an option: you are either in or out of the money. Potential credit risk could be infinite seen from today. If the stock price goes to $7,000,050 from today’s $50 the option seller (the other guy) owes you that massive amount for each option he’s sold to you. The higher the amount the more difficult for him to honor his obligation.

  3. For calls you would not exercise an American option early, same treatment.

HTH