# Credit Risk

CFAI book 5, P236, Reading 40. in Example 8 Q3. buy call option at \$35. currently worth \$46. what is the amount of credit risk? The answer is \$46. why is not 46-35=\$11? because if the call seller default the buyer’s loss is \$11 (he doesn’t need to exercise the option at \$35)?

The option is WORTH \$46. You have already paid your \$35…it is gone. Now you have to collect the \$46 and you might not if your counterparty defaults.

But if you haven’t exercised it yet then you just paid the premium not \$35. So the potential credit risk is \$11 ( assuming it is american option and when you are going to excercise with the current market price at \$46 while the seller default).

i think the book says \$35 is what the buyer paid for the option. it also sounds like it’s the strike price as well. that’s odd, isn’t it? in any case, the point is that he paid \$35 for a stock that is now worth \$46. \$46 is the amount “at risk” b/c he’s counting on the seller making good on the payoff (\$35 + \$11 appreciation).

karatekid Wrote: ------------------------------------------------------- > But if you haven’t exercised it yet then you just > paid the premium not \$35. Option premium and option price are identical.

Option Premium is the cost of the option, which is different from the strike price. Lolly is right, the book says “if he exercised the option” meaning he paid \$35 already so the crdit risk is \$46. Another question on option credit risk… Ts bought a call option with exercise price of \$101 at the cost of \$6. current price is \$96. What is the current value of the potential credit risk?

maratikus Wrote: ------------------------------------------------------- > karatekid Wrote: > -------------------------------------------------- > ----- > > But if you haven’t exercised it yet then you > just > > paid the premium not \$35. > > Option premium and option price are identical. That is set! When I read first, i was confuse as well. Option Premiun = Option price . That is what you get when using either BlackScholes Model or a binomial tree.

0 ?

karatekid Wrote: ------------------------------------------------------- > Option Premium is the cost of the option, which is > different from the strike price. > > Lolly is right, the book says “if he exercised the > option” meaning he paid \$35 already so the crdit > risk is \$46. > > Another question on option credit risk… > Ts bought a call option with exercise price of > \$101 at the cost of \$6. current price is \$96. What > is the current value of the potential credit risk? I would think that at this point you do not have any credit risk since there is no intrinsic value to the option, only time value. The fact that you put “potential credit risk”, I guess it could be unlimited “potential” if the stock were to significantly increase in value.

It is on CFAI reading 40, Q17 B. It says the current value is \$6 and it will change with time, and TS bears the credit risk. How come it is \$6???

As I understand it, the current value of the potential credit risk for a european style option is always equal to the cost of the option at that point in time. The current cost of the option is 6\$. Hence this is the current value of the potential credit risk. No current credit risk since the option is a European style option. The current value of the potential credit risk will change with time because the cost of the option will change with time due to change in the price of the underlying.

If the counterparty defaults before expiration, your cost of the option is at risk (in this case \$6) in addition to any increase in value. I think if the default is at expiration and the option has no value there is no credit risk.