Section 3

# Section 3 - ECON 136 Financial Economics Section 3(Sep 11th...

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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 Put-Call Parity Let±s consider an economy with four assets: a stock S , a risk-free 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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You 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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Section 3 - ECON 136 Financial Economics Section 3(Sep 11th...

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