FBE459_3_2_Options_Arbitrage

FBE459_3_2_Options_Arbitrage - Lecture Outline: FBE 459...

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1 FBE 459 – Financial Derivatives Prof. Pedro Matos Lecture 3.2: Option Arbitrage Relations Factors Influencing Option Prices • Factors Influencing Option Prices • Put-Call Parity • Bounds for Option Prices • Early Exercise Readings: HULL chapter 9 • Factors Influencing Option Prices • Put-Call Parity • Bounds for Option Prices Lecture Outline: 2 • Early Exercise • Effect of Dividends Notation c : European call option price p : European put option price S 0 : Stock price today C : American Call option price P : American Put option price S T :Stock price at option 3 K : Strike price T : Life of option : Volatility of stock price maturity D : Present value of dividends during option’s life r : Risk-free rate for maturity T with cont comp Option Prices Price of Call Payoff of Call c ? Profit at maturity (t=T) now (t=0) 4 S 0 K KS T Price of Put Payoff of Put S 0 p K ? Profit T
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2 Factors Influencing Option Prices cpC P Variable S 0 K ++ + ? ? + + –– + 5 T r D ++++ + + + + Factors Influencing Option Prices . Stock Price (S 0 ) => call (put) options more (less) valuable . Strike Price (K) => call (put) options less (more) valuable . Time to Expiration (T) => American options always more valuable. Not always true for European options (dividends) 6 . Volatility ( ) => always good for call/put option value because higher chance of extreme events is good since
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FBE459_3_2_Options_Arbitrage - Lecture Outline: FBE 459...

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