Sigma Inv bought a American call option on a security .The call option has an exvercise price of of 65 and was purchased afor 3.5 per option .The current value of the option is 8.5…
If the security held by Sigma trades at 70,the credit risk is closest to
A. 8.5
B.3.5
C.5
Answers plss
A
C. The option was bought for 3.5 but has moved to 5 ITM so the credit risk is 5… please tell me i’m right!!! arghh!!!
Credit risk on options is the market value which is 8.5.
FYI
If this was an European stype option,
“current credit risk” = 0
“value of potential credit risk” = 8.5
yes thats correct…Answer is 8.5
Please care to elaborate why the answer is 8.5 and not 5
The credit risk should be what you paid for it - Isn’t it?
Right, A. So irrespective of what you paid it’s worth 8.5 now. So, if your counterparty leaves you high and dry you’re out 8.50.
I had asked the same question…
Opton is not at expiration. so apart from intrinsic value, there is time value of money.
Hence the option is currently 8.5 and that is what the credit risk is.
It’s easier to get it if you think like this: you bought the option 1 month ago, so you have already spent $3.5 (since you pay upfront when you buy options!). So forget about the $3.5. If the counterpart leaves you cold, you are sitting there with something that has value ($8.5) and cannot claim it back. Hence, not matter if you paid something 1 month ago, your credit risk now is the MV of that option. Best, D.