OTM MBI Puts - Do I have these odds right?

[Daal]

I rarely use options so please someone tell me if this is right
I'm looking at MBIA 2009 Jan puts
for $2.5 YBUMY they cost 0.30
If believe MBI reaches $1 by then, does that the odds I'm getting here are $2.5 - $0.3 -$1/$0.3 = 4-1 odds?

 

[Kash]

You mean Risk to Return Ratio?
Yes, your MaxReturn/MaxRisk will be 4:1, if Stock reaches $1 on Expiration date.

If you are talking about odds of you ending profitable, thats a probability of Profit. It depends on the volatility of MBIA.

 

[Mvic]

If you are talking about what current prices are indicating the probability of MBI touching $1 by Jan 09 is my software is saying it is 3%. I have no idea how to calculate it myself.

By the way congratulations on FNM/FRE.

 

[Daal]

thks. I'm just referring to the odds on my bet if turns out im right. similar to the 'pot odds' in poker. but it looks like the market run away from me, bummer

 

[panzerman]

To calculate the actual odds at expiration (and under a perfectly Gaussian distribution assumption), put these formulas into Excel.

std. devs. = (ln(future_price/current_price))/(volatility*sqrt(days_til_expiry/252))

probability = normsdist(std. devs.)

The probability is the area under the bell curve to the left of the future_price. The probability of finishing to the right of the future_price is (1-probability).

 

[MasterAtWork]

Hi panzerman,

Quote from panzerman:

To calculate the actual odds at expiration (and under a perfectly Gaussian distribution assumption), put these formulas into Excel.

std. devs. = (ln(future_price/current_price))/(volatility*sqrt(days_til_expiry/252))

probability = normsdist(std. devs.)

The probability is the area under the bell curve to the left of the future_price. The probability of finishing to the right of the future_price is (1-probability).

It could be interesting to show how do you derive your formula. Could you please explain it?

Thx

 

[panzerman]

Quote from MasterAtWork:

Hi panzerman,



It could be interesting to show how do you derive your formula. Could you please explain it?

Thx

It comes out of the mathematics of options pricing.

 

[MasterAtWork]

Quote from panzerman:

It comes out of the mathematics of options pricing.

Yeah, which ones ?

I got a little knowledge about option pricing so if you could lead us to understand where it comes from, it would be nice.

Thanks in advance