03rec6

03rec6 - 15.407 Recitation October 23, 2003 MIT Sloan...

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Unformatted text preview: 15.407 Recitation October 23, 2003 MIT Sloan School of Management Things to cover today: Options: 1. Price bounds for options 2. American option and early exercise 3. Factors affecting price of option 4. Ways to price options 5. Risk Neutral Pricing Price bounds: There are upper bounds and lower bounds to the price of all options. Let B be the price of a discount bond with maturity same as futures. For calls, S- KB C c S For puts, K p P K B- S The bounds are usually not tight, but figuring out how to get the bounds is a very good test of your understanding to no-arbitrage. Put-Call Parity: This always hold in equality for European calls and puts on stocks that dont pay dividend. C- P = S- KB , where C and P have same strike (K) and maturity (same as B) If LHS RHS, then you just buy the RHS port- folio and short the LHS portfolio. To buy the RHS portfolio, you buy one unit of stock, and borrow KB. You will need to pay S-KB as a cost. Then you write a call and buy a put, this will give you a payment larger than your cost of buying the RHS portfolio. However, you will always have zero payoff at maturity....
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03rec6 - 15.407 Recitation October 23, 2003 MIT Sloan...

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