A Bramble-esq question.

[MrGecko]

It is still completely rational (in the sense of having +ve expectancy) to bid up to 60 cents for the option and up to 100.20 for the stock.

No, it's not, because you can create a risk free portfolio with a better return (see example above of paying $0.60)

 

[arabianights]

So what? There isn't a finite universe of rational investment strategies.

 

[MrGecko]

But , ceteris paribus, there is an optimal investment strategy of reward per unit risk.

 

[arabianights]

although no one knows what it is, so

 

[MrGecko]

well think of your efficient frontiers - the risk free price of the option is $0.50 and it's delta is 0.5 (co-incidence of the figures I chose).

Any price other that $0.50 is going to give you the same delta, but take you off the curve.

Anyhow - it's a no arbitrage argument. No-one is going to sell you the option for $0.60 because that would give them a RISK FREE LOSS (ignoring the fact that they could then go and buy if on the open market for $0.50, which is kinda the whole point that they could).

 

[N Rothschild]

u 2 need to get a life!! lol

 

[arabianights]

to introduce an EFF you need to bring in more controversial stuff (not sure if Markowitz is enough or if it's CAPM) than delta...

It also makes no sense to speak of it in terms of this question

 

[MrGecko]

I know I know... the point is that if the price of the option is anything other than $0.50 it is inefficient.

 

[Skill Leverage]

Oh, to be an options trader in the 80s. The only problem with half of the Market Wizards is that they made most of their money in grossly inefficient markets years ago.

 

[arabianights]

I know I know... the point is that if the price of the option is anything other than $0.50 it is inefficient.

And the stock price is inefficiently priced at $100

 

[MrGecko]

Nope, the stock price accounts for the expectancy of tomorrows closing price. We are valuing the options in terms of the stock price, remember.

 

[arabianights]

The stock price does not account for the expectancy of tomorrows closing price, otherwise it would be 100.20

 

[MrGecko]

Yes, it does.

Dave this is a one step binomial problem, textbook stuff.

(infact the example is from a textbook. You wanna argue with Paul Wilmott?)

 

[Skill Leverage]

I ate a big red candle

 

[arabianights]

It doesn't matter, the question is what is rational for you to bid on the option, and the answer to that is anything up to 60 cents

 

[arabianights]

I ate a big red candle

go down well?

 

[MrGecko]

Dave, I at least think you should buy him a drink before you start making such enquiries...

 

[Skill Leverage]

It went down better than a Patrick Swayze joke in a cancer ward

 

[TheHoneyMonster]

yes i can see why that wouldnt work.

 

[arabianights]

tell me a Patrick Swayze joke Uncle Leverage