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the part i think you've 'messed up' is that you haven't taken into
account of the initial cost. yes there's a 0.9 chance for him to make
$5, but also remember there's a 0.1 chance for him to LOSE $4, but
you've attached $0 instead of -$4 with that probability ;)
although i must say we've grossly simplified this calculation. do
remember that break even point (according to him, i can't be bothered
to look up the actual prices :p) is at $109, and at $108 he loses $1,
at $107 he loses $2 etc. so us assuming that pay off is actually
either only $5 or -$4 has actually understated the actual payoff. if
we do it 'properly' and attach probabilities to every single cent
going from $105 to $109, i suspect that the expected payoff should be
more around 4-5%.
> > i absolutely agree and am happy with the odds. I personally think
> > that AAPL will close below $110 at end of June with less than 1 in 10
> > chance, and with a 25% payoff with that chance, my expected payoff is
> > 2.5% return.
> > but i'd say an expected value of 2.5% return is a bit too low for a
> > 260k investment, for me anyways. so i'll probably be doing just that
> > but with 2% of the amount you've invested in :p
> I actually think Lev's play is a pretty reasonable one, if he strongly
> believes that Apple will stay above $110 and he has the bankroll. I
> was considering something similar with about 5% of my portfolio. Lev,
> you have $5 million to work with?
> dnl, as for your calculation of a return of 2.5%, I'm just not sure
> where you're getting that. According to your estimate that there's a
> 10% chance of AAPL being below $110, he has a 90% chance of making a
> 25% return (in less than a month). And he has a 10% chance of making
> less than that, all the way down to -100%. Sticking with your
> estimates, even if it was a 10% chance of a -100% return, I believe
> he's left with a 12.5% expected return (paid $4/share; expected value
> = 0.9 * $5 + 0.1 * $0 = $4.5; $4.5/$4 = 112.5%)... again, in less than
> a month.
> If I'm messing something up here, let me know.
> Jon