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Unformatted text preview: Conversely if volatility decreases, the option value decreases. P is the REALIZED price of 175 ounce of gold next year If the price of 175 ounces of gold goes above $106,000, Jim Lytle's strategy pays off more than the client's strategy. On the other hand if the price of 175 ounces of gold stays below $106,000, the client's strategy provides greater payoffs. You can lock into the forward rate or sell immediately at the same spot rate. The payoffs under either action is the same. Selling today is better because of time value of money. Equate forward price = expected cash flows based on risk neutral probabilities: 20 = 25 * p + 15 * (1 - p)....
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- Spring '12