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Alexandru Bratu

Term Deﬁnition

share single unit of ownership in a corporation, mutual fund, or other organization

commodity generic term for any marketable item produced to satisfy wants or need, e.g. oil, gas

fungible property of a good or a commodity whose individual units are capable of mutual substitution

instrument tradable asset of any kind, either cash; evidence of an ownership interest in an entity

bond negotiable certiﬁcate that acknowledges the indebtedness of the bond issuer to the holder

debenture document that either creates a debt or acknowledges it, and it is a debt without collateral

equity stock or any other security representing an ownership interest

common stocks form of corporate equity ownership, a type of security

derivative contract between two parties that speciﬁes conditions under which payments are to be made between

the parties

forward non-standardized contract between two parties to buy or sell an asset at a speciﬁed future time at a

price agreed upon(delivery price) today

futures standardized contract between two parties to buy or sell a speciﬁed asset of standardized quantity

and quality for a price agreed today

option instrument that speciﬁes a contract between two parties for a future transaction on an asset at a

reference price (the strike)

swaps derivative in which counterparties exchange cash ﬂows of one party’s ﬁnancial instrument for those

of the other party’s ﬁnancial instrument

stock original capital paid into or invested in the business by its founders, it serves as a security for the

creditors of a business

security fungible, negotiable ﬁnancial instrument representing ﬁnancial value, i.e. debt - banknotes(bill, paper

money), bonds and debentures, equity - common stocks, derivative - forwards, futures, options and

swaps

underlying price or rate of an asset or liability but is NOT the asset or liability itself

arbitrage borrowing money to lend out again at a higher rate of interest

law of one price the same asset does not trade at the same price on all markets

inﬂation swap the linear form of an inﬂation derivative, an over-the-counter and exchange-traded derivatives that

is used to transfer inﬂation risk from one counterparty to another

volatility measure for variation of price of a ﬁnancial instrument over time

dividend payments made by a corporation to its shareholder members

call option a.k.a. call - a company makes a call when it asks buyers of its new shares to pay some or all of the

share price

put option contract between two parties to exchange an asset (the underlying), at a speciﬁed price (the strike),

by a predetermined date (the expiry or maturity)

1

1 Black - Scholes - Merton

deﬁnition mathematical model of a ﬁnancial market containing certain derivative investment instruments, giving

price of European-style options

S stock price

V (S, t) price of a derivative as a function of time and stock price

C(S, t) price of a European call option

P(S, t) price of a European put option

K the strike of the option

r annualized risk-free interest rate, continuously compounded

µ the drift rate of S, annualized

σ the volatility of the stock’s returns, this is the square of the quadratic variation of the stock’s log

price process

t a time in years, generally with t

now

= 0, t

expiry

= T

Π the value of a portfolio

N(x) standard normal cumulative distribution function, N (x) =

1

√

2π

x

−∞

e

−

z

2

2

dz

N

(x) probability density function, N

(x) =

e

−

x

2

2

√

2π

Assumption the price of the underlying asset(stock) follows a geometricBrownianmotion(continuous-time stochas-

tic process in which the logarithm of the randomly varying quantity follows a Brownian motion, i.e.

random motion within a speciﬁc medium)

∂S

S

= µdt +σdW

W=Brownian−motion

, with the equation

giving the inﬁnitesimal return on the stock has an expected value of µdt and a variance of σ

2

dt

BSM derivation the payoﬀ of an option V (S, T) at maturity is known. To ﬁnd its value at an earlier time we need to

know how V evolves as a function of S and t. By It¯ o’s lemma for two variables we have

dV =

µS

∂V

∂S

+

∂V

∂t

+

1

2

σ

2

S

2

∂

2

V

∂S

2

dt +σS

∂V

∂S

dW

Consider delta-hedge portfolio, with one option and long

∂V

∂S

shares at time t. The value of these

holdings is Π = −V +

∂V

∂S

S. Over the time period [t, t + ∆t] the total proﬁt or loss from changes in

the values of the holdings is: ∆Π = −∆V +

∂V

∂S

∆S. Now making the continuous model into more

discrete parts we get

∆S = µS∆t +σS∆W

∆V =

µS

∂V

∂S

+

∂V

∂t

+

1

2

σ

2

S

2 ∂

2

V

∂S

2

∆t +σS

∂V

∂S

∆W

with ∆Π =

−

∂V

∂t

−

1

2

σ

2

S

2 ∂

2

V

∂S

2

∆t giving

∂V

∂t

+

1

2

σ

2

S

2

∂

2

V

∂S

2

+rS

∂V

∂S

−rV = 0

Call option the value of a call option for a non-dividend paying underlying stock in terms of BSM parameters

C (S, t) = N (d

1

) S −N (d

2

) Ke

−r(T−t)

Put option the price of a corresponding put option based on put-call parity is

P (S, t) = Ke

−r(T−t)

−S +C (S, t) = N (−d

2

) Ke

−r(T−t)

−N (−d

1

) S

2

Greeks(ﬁnance)

def:= measure the sensitivity to change of the option price under a slight change of a single parameter while holding the

other parameters ﬁxed

Measures What Calls Puts

value e

−qτ

SΦ(d

1

) −e

−rτ

KΦ(d

2

) e

−rτ

KΦ(−d

2

) −e

−qτ

SΦ(−d

1

)

delta

∂V

∂S

e

−qτ

Φ(d

1

) −e

−qτ

Φ(−d

1

)

vega

∂V

∂σ

Se

−qτ

φ(d

1

)

√

τ = Ke

−rτ

φ(d

2

)

√

τ Se

−qτ

φ(d

1

)

√

τ = Ke

−rτ

φ(d

2

)

√

τ

theta −

∂V

∂τ

−e

−qτ

Sφ(d

1

)σ

2

√

τ

−rKe

−rτ

Φ(d

2

) + qSe

−qτ

Φ(d

1

) −e

−qτ

Sφ(d

1

)σ

2

√

τ

+ rKe

−rτ

Φ(d

2

) + qSe

−qτ

Φ(d

1

)

rho

∂V

∂r

Kτe

−rτ

Φ(d

2

) −Kτe

−rt

Φ(−d

2

)

gamma

∂

2

V

∂S

2

e

−qτ

φ(d

1

)

Sσ

√

τ

e

−qτ

φ(d

1

)

Sσ

√

τ

vanna

∂

2

V

∂S∂σ

−e

−qτ

φ(d

1

)

d

2

σ

=

ν

S

_

1 −

d

1

σ

√

τ

_

−e

−qτ

φ(d

1

)

d

2

σ

=

ν

S

_

1 −

d

1

σ

√

τ

_

charm −

∂

2

V

∂S∂τ

qe

−qτ

Φ(d

1

) −e

−qτ

2(r−q)τ−d

2

σ

√

τ

2τσ

√

τ

−qe

−qτ

Φ(−d

1

) −e

−qτ

φ(d

1

)

2(r−q)τ−d

2

σ

√

τ

2τσ

√

τ

speed

∂

3

V

∂S

3

−e

−qτ

φ(d

1

)

S

2

σ

√

τ

_

d

1

σ

√

τ

+ 1

_

= −

Γ

S

_

d

1

σ

√

τ

+ 1

_

−e

−qτ

φ(d

1

)

S

2

σ

√

τ

_

d

1

σ

√

τ

+ 1

_

= −

Γ

S

_

d

1

σ

√

τ

+ 1

_

zomma

∂

3

V

∂S

2

∂σ

e

−qτ

φ(d

1

)(d

1

d

2

−1)

Sσ

2

√

τ

= Γ

_

d

1

d

2

−1

σ

_

e

−qτ

φ(d

1

)(d

1

d

2

−1)

Sσ

2

√

τ

= Γ

_

d

1

d

2

−1

σ

_

color

∂

3

V

∂S

2

∂τ

−e

−qτ

φ(d

1

)

2Sτσ

√

τ

_

2qτ + 1 +

2(r−q)τ−d

2

σ

√

τ

σ

√

τ

d

1

_

−e

−qτ

φ(d

1

)

2Sτσ

√

τ

_

2qτ + 1 +

2(r−q)τ−d

2

σ

√

τ

σ

√

τ

d

1

_

DvegaDtime

∂

2

V

∂σ∂τ

Se

−qτ

φ(d

1

)

√

τ

_

q +

(r−q)d

1

σ

√

τ

−

1+d

1

d

2

2τ

_

Se

−qτ

φ(d

1

)

√

τ

_

q +

(r−q)d

1

σ

√

τ

−

1+d

1

d

2

2τ

_

vomma

∂

2

V

∂σ

2

Se

−qτ

φ(d

1

)

√

τ

d

1

d

2

σ

= ν

d

1

d

2

σ

Se

−qτ

φ(d

1

)

√

τ

d

1

d

2

σ

= ν

d

1

d

2

σ

Ultima

∂

3

V

∂σ

3

−ν

σ

2

_

d

1

d

2

(1 −d

1

d

2

) + d

2

1

+ d

2

2

¸

−ν

σ

2

_

d

1

d

2

(1 −d

1

d

2

) + d

2

1

+ d

2

2

¸

dual delta

¸

¸

∂V

∂S

¸

¸

−e

−rτ

Φ(d

2

) e

−rτ

Φ(−d

2

)

dual gamma

¸

¸

¸

∂

2

V

∂S

2

¸

¸

¸ e

−rτ

φ(d

2

)

Kσ

√

τ

e

−rτ

φ(d

2

)

Kσ

√

τ

where

_

¸

¸

¸

¸

¸

¸

_

¸

¸

¸

¸

¸

¸

_

d

1

=

1

σ

√

τ

_

ln

_

S

K

_

+

_

r −q +

σ

2

2

_

τ

_

d

2

=

1

σ

√

τ

_

ln

_

S

K

_

+

_

r −q −

σ

2

2

_

τ

_

= d

1

−σ

√

τ

φ(x) =

1

√

2π

e

−x

2

2

Φ(x) =

1

√

2π

_

x

−∞

e

−y

2

2

dy = 1 −

1

√

2π

_

∞

−x

e

−

y

2

2

dy

with

S stock price

K strike price

r risk free rate

q annual dividend yield

τ T - t = time to maturity

σ volatility

φ standard normal probability density function

Φ standard normal cumulative distribution function

1

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