Chapter 13- Option Pricing with applications to real options

Chapter 13- Option Pricing with applications to real...

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Chapter 13 – Option pricing with applications to real options Options contracts are leveraged instruments offering an attractive risk structure and are used for hedging and speculation Because of their risk-return characteristics they can be used insure an existing portfolio The markets and instruments The principle of an option Definition – an option gives the buyer the right but not the obligation to buy or sell a good, and the option seller must respond accordingly A call (put) gives the buyer of the option contract the right to buy (sell) a specified number of units of an underlying asset at a specified date, called the expiration or strike date In all cases, the seller of the option contract, the writer, is subject to the buyer’s decisions and the buyer exercises the option only when it is profitable to him Buyer of a call (put) benefits if the price of the asset is above (below) the exercise price at expiration European-type option – can be exercised only on a specified date (expiration date) American option – can be exercised at any time until the expiration date Trading in listing options The option to buy an asset has a price must be paid at the time of contracting The price of an option (premium) fluctuates over time depending on the value of the underlying asset and other parameters Option is usually defined by the underlying asset, the exercise price and the expiration date At expiration, the option will make a profit if the difference between the share price and the exercise price is larger than the initial investment (premium) The Black-Scholes option pricing model Assumptions stock price behaviour corresponds to the lognormal model with μ and σ constant no transaction costs and taxes
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Chapter 13- Option Pricing with applications to real...

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