Chapter 16

Chapter 16 - 16-116-1Option Valuation•Our goal in this...

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Unformatted text preview: 16-116-1Option Valuation•Our goal in this chapter is to discuss stock option prices and its determining factors.•We will discuss "implied volatility," which is the market’s forward-looking uncertainty gauge.16-216-2The Black-Scholes-Merton Option Pricing Model•The Black-Scholes option pricing model says the value of a stock option is determined by five factors:S, the current price of the underlying stock.K, the strike price specified in the option contract.r, the risk-free interest rate over the life of the option contract.T, the time remaining until the option contract expires.σ, (sigma) which is the price volatility of the underlying stock.16-316-3The Black-Scholes-Merton Option Pricing Formula•The price of a call option on a single share of common stock is: C= SN(d1) – Ke–rTN(d2)•The price of a put option on a single share of common stock is: P= Ke–rTN(–d2) – SN(–d1)d1and d2are calculated using these two formulas:( 29( 29TσddTσT2σrKSlnd1221-=+×=16-416-4Formula Details•In the Black-Scholes formula, three common functions are used to price call and put option prices:–e-rt, or exp(-rt), is the natural exponentof the value of –rt (in common terms, it is a discount factor)–ln(S/K) is the natural logof the "moneyness" term, S/K.–N(d1) and N(d2) denotes the standard normal probabilityfor the values of d1 and d2. •In addition, the formula makes use of the fact that: N(-d1) = 1 - N(d1) 16-516-5Varying the Option Price Input Values•An important goal of this chapter is to show how an option price changes when only oneof the five inputs changes.16-616-6Varying the Underlying Stock Price16-716-7Varying the Time Remaining Until Option Expiration16-816-8Varying the Volatility of the Stock Price16-916-9Varying the Interest Rate16-1016-10Calculating Delta•Deltameasures the dollarimpact of a change in the underlying stock price on the value of a stock option....
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This note was uploaded on 11/18/2011 for the course FIN 355 taught by Professor Phsiao during the Fall '08 term at S.F. State.

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Chapter 16 - 16-116-1Option Valuation•Our goal in this...

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