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Pastimes : Clown-Free Zone... sorry, no clowns allowed

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To: tyc:> who wrote (105137)	5/28/2001 1:02:27 AM
From: Mark Adams	Read Replies (1) of 436258

My take on it; Risk free interest rate does apply to options pricing for the time value premium- but often is swamped by volatility. I'd take DAKs suggestion and treat it as an Interest problem. ie, calculate the Net Present Value of (Current Price of Gold - $220) received 4 years hence. This might be low. Idea being if you owned the right to one ounce of gold 4 years from now, you could sell the ounce at todays price and cover in the future. In the mean time, you invest the short proceeds in 'risk free' t-bills. This would be a slightly different calc, in that you get the premium plus the discounted interest flow for the four years. Still just a variation on NPV. Even this might just be a floor valuation. If you consider the possibility that gold may increase during the 4 years, and decide against hedging to 'lock in' a 'risk free' return, then you might have to add in the volatility component, likely using the Black-Scholes model. As LTCM proved, even good models might err in pricing unlikely events, such as 00 on the ol roulette wheel. So in the end, you have just a set of approximations based on expectations.

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