FIN 4504 Lecture Notes - Lecture 26: Option Style, Compound Interest, Arbitrage

• School: University of Florida
• Department: Finance, Insurance and Real Estate
• Course: FIN 4504
• Professor: Li Qing

Document Summary

Step 1: work out all stock prices. In two-period model, there are 2+4 = 6 of them. Step 2: work out all cxx at the termination (4 of them). Step 3: use one-period model to solve for cx (2 of them) Step 4: use one-period model to solve for c0. So far we have focused on pricing of call options . Put options prices can be derived simply from the prices of calls because prices of european put and call options are linked together in an equation called put-call parity. We found that you can replicate a certain/riskless payoff by combining a stock, a put and writing a call. Costs of buying a put, buying the stock, writing a call should be identical to the cost of a risk-free bond that pays x (strike price) at maturity (expiration date). > buying a bond is equivalent to lending money.