FINE 2000 Study Guide - Quiz Guide: United States Treasury Security, Arbitrage, Basis Point
Document Summary
Option values may be viewed as the sum of intrinsic value plus time or (cid:498)volatility(cid:499) value. The volatility value is the right to choose not to exercise if the stock price moves against the holder. Thus the option holder cannot lose more than the cost of the option regardless of stock price performance. Call options must sell for at least the stock price less the present value of the exercise price and dividends to be paid before expiration. This implies that a call option on a non-dividend-paying stock may be sold for more than the proceeds from immediate exercise. Thus european calls are worth as much as american calls on stocks that pay no dividends, because the right to exercise the american call early has no value. Options may be priced relative to the underlying stock price using a simple two- period, two- state pricing model.
