Unformatted text preview: gh! Discussion of Binomial Pricing
Question 1: Why does option price not depend on the
probabilities?
A mechanical answer: arbitrage does not depend on
probability
A deeper answer: information about probability already
contained in today’s stock price
Question 2: Does this mean that news about the stock price
movement will not aﬀect the price of the call option?
It will. In fact, it will aﬀect both.
Question 3: Why can we replicate the call option in this case?
Binomial assumption is the key Summary So Far We have seen how to price option in the twoperiod binomial
setting.
We saw two ways to do it:
1 Find replicating portfolio with two equations and two
unknowns 2 Find the stock ∆ to hedge the option position This is pretty cool: we now know how to do some complicated
pricing we didn’t know how to do before. What is next? More things we can do with this model:
1 Multiperiod setting 2 Another way to compute the prices: riskneutral pricing Riskneutral pricing will be pretty really cool because we will be
able to think more about the economics behind the prices....
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 Spring '13
 Options, Mathematical finance, CF

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