Download Chapter III. Using OptionExpert cont`d

In order to accept or reject the call contract being considered, you
have to be able to determine its economic value and compare that
economic value with other alternative option positions. The criterion
for evaluation of the economic value is expected profit.
Expected profit is not the same as the actual profit from the contract.
Actual profit is not known until the option expires. Depending on the
index value at the time of expiration, the option will have value or
may expire worthless. The value at expiration depends on the value
of the index. With a strike price of 270, the option will expire
worthless if the index is anything less than 270. If the index reaches
272, then the option has a value of 200. If the value of the index at
expiration is 278, then the option will have a value of 800, etc.
What will happen in the future, one has no way of knowing. All you
can do is take your best guess with the information that is available.
The information available is represented in Diagram 3, and again in
Table 1. That information includes the option terms (strike = 270
and time to expiration = 45 days) and the current price of the option,
350/per contract.
TABLE 1
Price
Probability
Conditional
Option
Value
Option
Cost
Conditional
Profit
(Loss)
Conditional
Expected
Profit
271
272
.02
.04
$100
200
$350
350
($250)
(150)
($5.0)
(6.0)
273
274
.14
.18
300
400
350
350
(50)
50
(7.0)
9.0
275
276
.24
.13
500
600
350
350
150
250
36.0
32.5
277
278
.09
.06
700
800
350
350
350
450
31.5
27.0
279
280
.04
.03
900
1000
350
350
550
650
22.0
19.5
281
282
.02
.01
1100
1200
350
350
750
850
15.0
8.5
Expected Profit =
$183
Expected ROI =
183
350
= 52%
Chapter III: Finding Positions
49