Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Politics : Formerly About Advanced Micro Devices -- Ignore unavailable to you. Want to Upgrade?

To: Joe NYC who wrote (107972)	4/26/2000 3:06:00 PM
From: Petz	Read Replies (1) \| Respond to of 1570498

Jozef, re: <<For a stock with a positive alpha, Black Scholes option valuation will: 1. say that call options are less valuable than they really are 2. say that put options are more valuable than they really are>> Since there is a conversion between a call and a put, (I forgot what it is exactly) there is no way they can get out of line from each other, no matter how positive the uptrend is. I think it would open the door to arbitrage, which would bring puts and calls back to parity (except for slight premium of calls over puts due to the carrying cost of the hedge - which is basically the interest on money you have to borrow to buy the long position to hedge your short call) For example, with stock at 85, the price of the 85 put has to be equal to the price of 85 call + interest on $85 for the duration of the call. > Basically, what you just proved is that market forces will keep the actual prices of calls and puts close to their theoretical values according to Black-Scholes valuation. (BTW, the call price=the put price PLUS interest) And, if you threw darts at the option page and bought these calls and puts at no commision, and they are all selling at their Black Scholes price, you would break even, on average, although most of your options would expire worthless. If a stock is behaving according to a true random walk: STOCK(N+1) = STOCK(N) + R, where R is a random number with zero mean and all of its options are priced exactly according to Black Scholes, then, on average, I would neither gain nor lose money no matter what option strategy I chose. But if I somehow KNOW that the price of AMD is based on the following formula: AMD(N+1) = AMD(N) + R + a*AMD(N), where a>0, and R is a random number with zero mean, then I can maximize my gains buying calls, and the "excess return" will be maximized with longer term calls because over a longer time period, the exponentially increasing stock price due to the "a" factor will overcome the sum of the random components, which only grow as the square root of the number of days. My only purpose in bringing this up was to point out that there is a sound theoretical basis for buying longer term call options under certain situations. Petz