ECON 136: Financial Economics
Section 3 (Sep 11th)
Xing Huang
1
Economics Department, UC Berkeley
1
Bid Price / Ask Price
Bid Price: the price the dealer is willing to pay to buy a security from the investor.
Ask Price: the price the investor pay when the investor are buying a security.
Ask Price
>
2
Options
2.1
Call Options
A European call option is the right but not the obligation to buy the underlying asset
S
, at the
expiration date
T
X
(the strike price). The payo/ of a European call is
thus,
C
T
= max
f
S
T
±
X;
0
g
2.2
Put Options
A European put option is the right but not the obligation to sell the underlying asset
S
, at the
expiration date
T
X
(the strike price). The payo/ of a European call is
thus,
P
T
= max
f
X
±
S
T
;
0
g
2.3
PutCall Parity
Let±s consider an economy with four assets: a stock
S
, a riskfree bond, a put option on the stock
P
, and a call option on the stock
C
. The options both have the same expiration date
T
and strike
price
X
. Looking at the payo/s of the four assets reveals that one of the assets is redundant. Here
is another way to form two portfolios which have the same payo/ in any state.
Payo/ of portfolio 1 (buy call, sell put)
C
T
±
P
T
= max
f
S
T
±
X;
0
g ±
max
f
X
±
S
T
;
0
g
=
S
T
±
X
Payo/ of portfolio 2 (buy stock, borrow strike)
S
T
±
X
1
Thank you all very much !!
1
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View Full DocumentYou could try to draw the payo/ diagrams of these two portfolioes by your own, and will also
get the same payo/s. Since these payo/s are equivalent, if LOOP holds then the portfolio prices
must be equal. Let
S
t
,
C
t
, and
P
t
denote the price of the stock, call, and put at time
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 Fall '08
 SZEIDL
 Economics, Expiration date

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