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Bounds and Option Values

 

  • The value of an option changes over its life
  • Consider the earlier illustration of the call
  • If the share price of is below 5 on the exercise date, the call will be worthless
  • If the stock price is above 5, the call will be worth 5 less than the value of the stock
  • Even before maturity of the option, its value can never remain below this lower-bound line
  • For options that still have some time to run, the heavy lower line is thus the lower-bound limit on the market price of the option
  • The diagonal line in the plot is the upper bound limit to the option price, because the stock gives a higher ultimate pay-off than the option

  • The value of an option changes over its life
  • Consider the earlier illustration of the call
  • If at the option’s expiration, stock price > exercise price, the option is worth the stock price minus the exercise price
  • If the stock price < exercise price, the option is worthless. But the share owners still have a valuable financial asset in the form of stock of ABC Corporation
  • The value of the option would lie between these two bounds throughout the option’s life


 





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