Week 3: Option and option pricing model

Question 1

What is a call option?

Answer 1

They are like down-payments
By buying a call, you reserve a price on the stock.
If the stock settles above the price, you can buy it at the predetermined price. Although you have no obligation to do so.
(Betting on the price increasing)

Question 2

What is a pull option?

Answer 2

They are like insurance.
If the stock price falls below strike price, you can sell at the higher, predetermined price.
(Betting on the price decreasing)

Question 3

What is an American option?

Answer 3

You can exercise the stock before or at maturity.

Question 4

What is a European stock?

Answer 4

You can only exercise at the maturity date.

Question 5

Ct

Answer 5

max ( 0, St - K )

Question 6

Pt

Answer 6

max ( 0, K - St )

Question 7

What does St, K, Ct, Pt stand for?

Answer 7

St = Stock price
K = Strike price
Ct = call price
Pt = Put price

Question 8

What happens if this equation does not hold?
C + PV (K) = P + S

Answer 8

Then there will be opportunity for arbitrage profit opportunity.
(This is only for European option)

Question 9

What happens if you cannot agree on a U and D?

Answer 9

You will make U and D smaller and smaller, until you agree on a number. For example, if you cannot agree on stock price for one day, try one minute, then one second, until youb agree.