Option Pricing Flashcards
What is the Binomial tree ?
-A digram the depicts the different possible paths that the stock price might follow over the life of an option
What are some assumptions of the binomial tree ??
- Stock prices follow a random walk
- no arbitrage opportunities
what is the simple binomial model ?
What does the binomial tree look like for a call option
Binomial tree for setting up a riskless portfolio
What is the value of the portfolios if the stock prices change ?
How would you value this option
What are the notations of the one-step tree ??
using the one step method when is the portfolio riskless ??
Write this in words
The portfolio is riskless when the value of stock at time T if the price goes up multiplied by the ratio of the change in the option price to the change in the stock price take away the value of the call option at time T if stock price goes up, is equal to when the value of stock at time T if the price goes down multiplied by the ratio of the change in the option price to the change in the stock price take away the value of the call option at time T if stock price goes down
What is delta in option pricing ??
The ratio of the change in the option price to the change in the stock price
How do you find delta in option pricing
What is the equation to find the option value in the general one-step method ?
In option pricing what is the binomial tree looking like with probability included ?
p and 1-p are up and down movements in stock price
Using option pricing with probabilities work out the price of this option
Why when pricing an option does the risk preferences not matter ??
-The expected return on a stock (or any other investment) is the risk-free rate.
-The discount rate used for the expected payoff on an option (or any other instrument) is the risk-free rate.
-This gives the right price for a derivative in all worlds
Show the general two-step model
What is the equation for a two-step call option price ?
What is the equation for a two-step put option price ?
For the two-step option pricing method how do u find P
Give an example of a Delta ratio and explain how it hedges risk
-If the delta ratio is 0.25% than 0.25 share of stock must be held in the the portfolio to hedge away risk
What is Delta ?
-The ratio of the change in the option price to the change in the price of the underlying asset
-It is also a hedge ratio that provides insurance to the option portfolio value against share price movements
What is the differences of delta in a call option and put option ??
Delta in a call is positive, whereas delta in a put is negative
Does the value of delta stay the same from node to node ??
No it doesn’t it varies
How do you choose the parameters u and d ??
They show be chosen to match the volatility of the stock price
Probability for assets other than non-paying dividends
