1Managerial FinanceLecture 18Options Pricing, Executive Compensation and Option SensitivitiesClass 17. Summary•The prices of European call and put options are related by put-call parity•American calls & puts always havenon-negative “time value”American calls & puts always have non-negative American calls should not be exercised early unless they pay dividendsAmerican puts may be exercised early when interest on strike is high•Binomial model: calls, puts and all other derivative securities can be priced by no-arbitrageargumentsSteps:1. Find the cash-flows of the options2. Find existing assets (shares and B bonds) that yield the same cash-flows 3. Find the price of those existing assetsand you are done!Call option: is always between 0 and 1 and T-Bill is between 0 and -KPut option: is always between 0 and -1 and T-Bill is between 0 and K2
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