FE_L3 Flashcards
1
Q
What is a call option?
A
- Right (not obligation) to buy an asset at a specified strike price
- Gains value if market price exceeds strike
2
Q
What is a put option?
A
- Right (not obligation) to sell an asset at a specified strike price
- Gains value if market price falls below strike
3
Q
What is an arbitrage opportunity?
A
- A sure-profit strategy with no net investment
- No possibility of loss
- Arises when related assets are mispriced
4
Q
What are the upper and lower bounds for a European call?
A
- Upper bound: C0 ≤ S0
- Lower bound: C0 ≥ max[S0 − PV(X), 0]
5
Q
What are the upper and lower bounds for a European put?
A
- Upper bound: P0 ≤ PV(X)
- Lower bound: P0 ≥ max[PV(X) − S0, 0]
6
Q
What is the Put-Call Parity?
A
- Formula: S0 + P0 = PV(X) + C0
- Ensures no arbitrage between (stock + put) and (bond + call)
7
Q
Which factors increase a call option price?
A
- Stock price (↑)
- Volatility (↑)
- Time to expiration (↑)
- Interest rate (↑)
- Strike price (↓)
8
Q
Which factors affect a put option price?
A
- Stock price (↓)
- Strike price (↑)
- Volatility (↑)
- Time to expiration (mixed effect)
- Interest rate (↓)
9
Q
What is the two-state option valuation model?
A
- Stock price can go to Su or Sd
- Replicate option payoff via stock + risk-free asset
- No-arbitrage determines option price
10
Q
What is the binomial model for pricing options?
A
- Extends two-state model to multiple periods
- Price evolves via repeated up/down factors
- Converges to Black-Scholes in the continuous limit
11
Q
What is the Black-Scholes formula for a European call?
A
- Formula: C0 = S0N(d1) − X e−rTN(d2)
- N(d): cumulative standard normal
- Depends on volatility, not on expected return μ
12
Q
What are the main takeaways of option valuation?
A
- Pricing relies on no-arbitrage principle
- Replication strategies link asset prices
- Put-Call Parity and binomial model
- Black-Scholes for continuous-time pricing
