Intrinsic value and Probability: Difference between pages

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1.  
The study of chance providing an objective measure of uncertainty.


The component of a the value of an option which relates to the gain - if any - which could be earned by immediate exercise of the option.


For a call option this is the excess - if any - of the underlying asset price over the strike price.
Probabilities range between 1 (=100%) and 0 (=0%).


For a put option it is the excess - if any - of the strike price over the underlying asset price.
A probability of 100% means that an event is considered certain to occur.  


A probability of 0% means that an event is considered certain not to occur. 


2.


The value of any financial asset determined by reference to the present value of its expected net future cash flows.  
For example, flipping an unbiased coin, the probability of getting a head is often modelled as 50%.




3.  
This simple model of a coin flip assumes that the only two possibilities are a head or a tail. Applying such simple models to financial situations, and treating financial outcomes as simple coin flips, may lead to errors resulting from:


More generally, the value of any asset determined by reference to its particular fundamental characteristics, rather than by reference to current market prices.  
#The coin landing on its edge 'more often than it's supposed to'.
#The underlying assumption of an unbiased coin not being a valid one. This kind of assumption is usually much too simple.




== See also ==
== See also ==
* [[Market value]]
* [[Black swan]]
* [[Present value]]
* [[Conditional probability]]
* [[Time value]]
* [[Confidence interval]]
* [[Frequency distribution]]
* [[Mutually exclusive]]
* [[Poisson distribution]]

Revision as of 15:19, 8 June 2016

The study of chance providing an objective measure of uncertainty.


Probabilities range between 1 (=100%) and 0 (=0%).

A probability of 100% means that an event is considered certain to occur.

A probability of 0% means that an event is considered certain not to occur.


For example, flipping an unbiased coin, the probability of getting a head is often modelled as 50%.


This simple model of a coin flip assumes that the only two possibilities are a head or a tail. Applying such simple models to financial situations, and treating financial outcomes as simple coin flips, may lead to errors resulting from:

  1. The coin landing on its edge 'more often than it's supposed to'.
  2. The underlying assumption of an unbiased coin not being a valid one. This kind of assumption is usually much too simple.


See also

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