A little confused on this (surprise): Schweser states that European option can only have potential credit risk. But in the same paragraph it goes on to say that in case of short position’s bankruptcy, the long can file claim in an amount equal to the PV of the value of the option. Is the PV current or future credit risk? I think the answer is that potential credit risk is associated with potential payments. Anyone knows better?
I believe PV = Current + Potential Credit Risk… can someone confirm?
This is very arbitrary in nature. The reason why there is not ‘current’ credit risk for the European options is that they can only be exercised in the future; hence the only credit risk is ‘potential’ credit risk at termination of the option. However if a counterparty is to file for bankruptcy protection the value of claim is, irrespective of the fact that it is a European option, is the current market value. I don’t agree that Current + Potential Credit Risk = PV. Potential Credit Risk is inherently unknown.