An option gives you the right but not the obligation to buy a security. Imagine you have an option to buy a stock in five years for $10. You are better off the higher the variance of the stock because you get all of the upside but in five years you are no worse off if the stock is worth $10 compared to anything below $10. Consequently, “black-swan” events raise the value of the option.
If today the stock is worth $4 and you believe it will probably be worth less than $4 in five years then the option still has value if there is a non-zero probability that the stock will be worth more than $10 in five years time.
Because of your future ability to commit suicide you have an option on your future life. This option value reduces the expected gain to you of committing suicide even if you would be better off today if dead than alive and you think that your life will probably be worse five years from now than it is today. Knowing you can commit suicide in five years, consequently, should make you much less willing to commit suicide today.
The analogy of life to an option isn’t perfect because with an option you don’t suffer while you wait for it to expire.
The analogy of life to an option isn’t perfect because with an option you don’t suffer while you wait for it to expire.
I would say that’s a fundamental and critical flaw in the analogy. Living five more miserable years and then committing suicide leaves you five miserable years worse off. All that you really need to calculate is the expected utility of staying alive.
I’m not sure I followed this. Is there something more to it than ‘wait a while, things might get better and you can always go through with it later if they don’t’?
Yes, the higher the variance of what might happen the more you should be willing to wait. Also, even if you think things will probably get worse option value means you might still want to wait.
Kids who are “sometimes suicidal” should learn a bit about option pricing theory.
Explain.
An option gives you the right but not the obligation to buy a security. Imagine you have an option to buy a stock in five years for $10. You are better off the higher the variance of the stock because you get all of the upside but in five years you are no worse off if the stock is worth $10 compared to anything below $10. Consequently, “black-swan” events raise the value of the option.
If today the stock is worth $4 and you believe it will probably be worth less than $4 in five years then the option still has value if there is a non-zero probability that the stock will be worth more than $10 in five years time.
Because of your future ability to commit suicide you have an option on your future life. This option value reduces the expected gain to you of committing suicide even if you would be better off today if dead than alive and you think that your life will probably be worse five years from now than it is today. Knowing you can commit suicide in five years, consequently, should make you much less willing to commit suicide today.
The analogy of life to an option isn’t perfect because with an option you don’t suffer while you wait for it to expire.
I would say that’s a fundamental and critical flaw in the analogy. Living five more miserable years and then committing suicide leaves you five miserable years worse off. All that you really need to calculate is the expected utility of staying alive.
I’m not sure I followed this. Is there something more to it than ‘wait a while, things might get better and you can always go through with it later if they don’t’?
No, but option pricing theory is the math behind that logic.
Yes, the higher the variance of what might happen the more you should be willing to wait. Also, even if you think things will probably get worse option value means you might still want to wait.
I’ll just let you two talk amongst yourselves....