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2properties of Stock Options

This document discusses key properties and relationships between stock options, including: 1) It defines the notation used for variables that determine option prices like the stock price, strike price, risk-free rate, volatility, and time to expiration. 2) It shows how these variables affect whether a call or put option price increases or decreases. For example, as the stock price increases calls increase in value and puts decrease. 3) It establishes that American options are always worth at least as much as equivalent European options due to having early exercise ability. 4) It provides inequalities that option prices cannot exceed, like a call never being worth more than the stock price or a put more than the strike price.

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Arijit Das
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44 views

2properties of Stock Options

This document discusses key properties and relationships between stock options, including: 1) It defines the notation used for variables that determine option prices like the stock price, strike price, risk-free rate, volatility, and time to expiration. 2) It shows how these variables affect whether a call or put option price increases or decreases. For example, as the stock price increases calls increase in value and puts decrease. 3) It establishes that American options are always worth at least as much as equivalent European options due to having early exercise ability. 4) It provides inequalities that option prices cannot exceed, like a call never being worth more than the stock price or a put more than the strike price.

Uploaded by

Arijit Das
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Properties of Stock Options

Notation
 C : American Call option
 c : European call price
option price  P : American Put option
 p : European put
price
option price  ST :Stock price at option
 S0 : Stock price
maturity
today  D : Present value of
 K : Strike price dividends during option’s
 T : Life of option life
 : Volatility of stock  r : Risk-free rate for

price maturity T with cont comp


Effect of Variables on Option
Pricing (Table 9.1, page 202)

Variable c p C P
S0 + – + –
K – +? – +
T ? + +
 + + + +
r + – + –
D – + – +
American vs European Options

An American option is worth at


least as much as the
corresponding European option
Cc
Pp
Upper Bounds for Call

Call option can never be worth


more than stock
S0  c, C
Example, S0 = 100, c = 110 ?
Upper Bounds for Put
American Put option can never be worth
more than strike price
K P
Example, K = 50, p = 55 ?

European Put option can never be worth


more than present value of strike price
Ke–rT  p
Example, K = 50, Ke–rT = 48, p = 49 ?
Lower Bound for European
Call Option Prices; No
Dividends

c  max(S0 – Ke–rT, 0)
Calls: An Arbitrage
Opportunity?
Suppose that
c=3 S0 = 20
T=1 r = 10%
K = 18 D=0

Is there an arbitrage opportunity?


Lower Bound for European Call
Option Prices; No Dividends
Amore formal argument,
Consider two portfolio
◦ Portfolio A: (One European call option +
cash amount of Ke–rT)
◦ Portfolio B: (One share)
Lower Bound for European Put
Prices; No Dividends

p  max(Ke -rT–S0, 0)
Puts: An Arbitrage
Opportunity?

Suppose that
p=1 S0 = 37
T = 0.5 r =5%
K = 40 D =0
Is there an arbitrage
opportunity?
Lower Bound for European Put
Option Prices; No Dividends
Amore formal argument,
Consider two portfolio
◦ Portfolio C: (One European put option +
One share)
◦ Portfolio D: (cash amount of Ke–rT)
Put-Call Parity; No Dividends
 Consider the following 2 portfolios:
◦ Portfolio A: European call on a stock + PV of the
strike price in cash
◦ Portfolio C: European put on the stock + the
stock
 Both are worth max(ST , K ) at the maturity of the
options
 They must therefore be worth the same today. This

means that c + Ke -rT = p + S0


Arbitrage Opportunities
Suppose that
c =3 S0 = 31
T = 0.25 r = 10%
K = 30 D=0
What are the arbitrage
possibilities when
p = 2.25 ?
p=1?

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