FBE459_3_2_Options_Arbitrage

# FBE459_3_2_Options_Arbitrage - FBE 459 Financial...

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FBE 459 – Financial Derivatives Prof. Pedro Matos Lecture 3.2: Option Arbitrage Relations Factors Influencing Option Prices Put-Call Parity Bounds for Option Prices Early Exercise Readings: HULL chapter 9

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2 Factors Influencing Option Prices Put-Call Parity Bounds for Option Prices Early Exercise Effect of Dividends Lecture Outline:
3 Notation c : European call option price p : European put option price S 0 : Stock price today K : Strike price T : Life of option σ : Volatility of stock price C : American Call option price P : American Put option price S T :Stock price at option maturity D : Present value of dividends during option’s life r : Risk-free rate for maturity T with cont comp

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4 Option Prices Price of Call Payoff of Call S 0 c K ? Profit K S T Price of Put Payoff of Put S 0 p K ? Profit K S T at maturity (t=T) now (t=0)
5 Factors Influencing Option Prices c p C P Variable S 0 K T σ r D + + + ? ? + + + + + + + + + + +

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6 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) . ↑ Volatility ( σ ) => 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 - FBE 459 Financial...

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