How you measue the potential credit risk of an option?
For example if I have pay 1 USD for a call option with a strike price of 100 and the underlying is 105. The current value is 5.
What would be my potential credit risk? 5 USD? or 5USD + 1 USD = 6USD?
thanks
Some call option that is, instant profit.
Anyway, your credit risk only applies to the payoff, since that’s the amount the counterparty is expected to pay,
Mr Smart, I dont know if you are wrong, but in the case of Laura Hackett in the mock exams the call option strike price is 65 USD and selling price is 70 USD.
I guess you would say potential credit risk is 5USD.
However, the credit risk is 5 USD + 3.50 USD (purchase price of call option) = 8.50 USD.
Does it make sense to you?
Mr Smart, I dont know if you are wrong, but in the case of Laura Hackett in the mock exams the call option strike price is 65 USD and selling price is 70 USD.
I guess you would say potential credit risk is 5USD.
However, the credit risk is 5 USD + 3.50 USD (purchase price of call option) = 8.50 USD.
Does it make sense to you?
option credit risk equals the value of the option, not just the amount you paid as premium
It does, I’m not sure why the premium would be part of your credit risk, I guess the CFAI realizes it as part of the whole position, so that’s what you should do.
My initial thoughts was the amount due from the counterparty.
The reason I can think of is this: since the option is in the money now and the short may not pay, the $5 is surely a credit risk. If the short doesn’t pay and you want to recover the premium paid by selling the option, then no one will pay you $3.5 to buy the option since the option is risky with the same counterparty. They may not buy the option from you at all. So you lose the $3.5 premium you paid also which can’t be recovered.
I’d add it also depends if it’s european or american.
If the above was an American option I agree on the 8.5 USD.
If it was European the (current) credit risk would only be 3.5 USD in my eyes.