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Extra resources for An introduction to options trading
Since the price of the option is more than its intrinsic value this would lead to a higher payoff than $10. An alternative strategy2 is to keep the option and short the underlying stock. This guarantees a payoff of at least $10. On top of that, interest is earned over $50, since this was received by shorting the stock, which is more than the interest earned on the $10 were the American option exercised immediately. This means that the discounted expected payoff is more than $10. However, for an American put option it can be profitable to exercise the option early.
This, in turn, makes it impossible for him to calculate the fair price of the option. However, he can try to estimate this volatility by looking at what the volatility has been so far, the historic volatility. Although there are techniques to estimate the volatility accurately, he will never be able to say with certainty what the volatility will be during the term of the option. In fact, from all the variables the Black–Scholes formula uses to determine the price of an option on a non-dividend paying stock, volatility is the only one that is really open to interpretation.
Every state refers to what would happen were the option exercised immediately. 4 Profit from writing a European put option on Unilever. Option price ¼ $3, Strike price ¼ $50. example, consider the call option on Royal Dutch/Shell with a strike price of $42. If the stock price of Royal Dutch/Shell is more than $42, the call option is in the money, because a profit would be made by exercising the option immediately. The call option is at the money if the stock price is $42, since neither a profit nor a loss would be made by exercising the option immediately.