CHAPTER SEVENTEEN
OPTION VALUATION
CHAPTER OVERVIEW
This chapter discusses factors affecting the value of an option, determination of option pricing in a two
state world (binomial option pricing), hedge ratios, and the BlackScholes option pricing model.
Portfolio insurance techniques are also presented.
LEARNING OBJECTIVES
After studying this chapter, the student should have a thorough understanding of the factors affecting
option prices, be able to compute option prices in the twoscenario model of the economy (binomial
option pricing), compute the Black Scholes value of an option, compute hedge ratios, and construct
portfolio insurance strategies using option hedge ratios.
PRESENTATION OF CHAPTER MATERIAL
1. Overview of Option Valuation
The concept of intrinsic value was developed in Chapter 16.
T 172 describes the concept of time value
of an option building on these concepts.
A graph that compares the intrinsic and time value of a call
option is displayed in T 173.
T 172 Option Values
T 173 Time Value of Options: Call
The factors that will have influence on the value of a call option are described in T 174.
The
relationship between the first two factors determines the intrinsic value.
Other factors constant, the
higher the stock price the higher will be the value of the call.
Other factors constant, the higher the
exercise price the lower will be the value of the call.
Options on stocks with greater volatility will be
more valuable than options on lower volatility stocks.
The payoffs from the call are not symmetric.
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 Spring '09
 MARTIN
 Management, Pricing, Options, Valuation, Mathematical finance, Black–Scholes

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