You are on page 1of 31

# A&J Flashcards for

Exam MFE/3F
Spring 2010

Alvin Soh
Outline
DM chapter 9 Parity and Other Option Relationship

## DM chapter 24 Interest rate models

DM Chapter 9- Parity and Other Option Relationship

## Put-call parity for European Options

DM Chapter 9- Parity and Other Option Relationship

C  K , T   P  K , T   e rT  F0,T  K  or

C  K , T   P  K , T   S0e T  Ke rT or

## C  K , T   P  K , T   S0  PV0,T  Div   Ke rT

DM Chapter 9- Parity and Other Option Relationship

## Put –call parity for American Options

DM Chapter 9- Parity and Other Option Relationship

C  K  PV  Div   S  P  C  PV  K   S or

P  S  PV  K   C  P  S  PV  Div   K

DM Chapter 9- Parity and Other Option Relationship

Create synthetic stock by applying put-call parity when the stock pays
discrete dividends.

DM Chapter 9- Parity and Other Option Relationship

## 1. Purchasing a \$K-strike call option;

2. Selling a \$K-strike put option;
3. Lend PV0,T  Div   Ke at risk-free rate.
 rT

DM Chapter 9- Parity and Other Option Relationship

Create synthetic stock by applying put-call parity when the stock pays
continuous dividend.

DM Chapter 9- Parity and Other Option Relationship

S0  e T  C  K , T   P  K , T   Ke rT 

## 1. Purchasing e T unit of \$K-strike call option;

2. Selling e T unit of \$K-strike put option;
  r T
3. Lend Ke at risk-free rate.

DM Chapter 9- Parity and Other Option Relationship
Given that K1  K 2  K3 ,

C  K1   C  K 2  C  K 2   C  K3 
1. 
K 2  K1 K3  K 2
P  K1   P  K 2  P  K 2   P  K3 
2. 
K 2  K1 K3  K 2

## To exploit the mispricing,

1. Sell n units of C  K 2  or P  K 2  ;
K3  K 2
2. Buy n units of C  K1  or P  K1  ;
K3  K1
K  K1
3. Buy 2 n units of C  K3  or P  K3 
K3  K1 .

DM Chapter 10 & 11- Binomial Option Pricing

## The amount of money lent, B to replicate an European option under

binomial pricing model

DM Chapter 10 & 11- Binomial Option Pricing

 uC  dCu 
B  e rh  d 
 u  d  

DM Chapter 10 & 11- Binomial Option Pricing

The risk-neutral probability that the underlying stock price will move to Su
on the date of expiry of the option

DM Chapter 10 & 11- Binomial Option Pricing

e
r   h
d
p 
*

ud

DM Chapter 10 & 11- Binomial Option Pricing

## 1. One plus the rate of capital gain on the stock if it goes up in

binomial pricing model, u ;
2. One plus the rate of capital loss on the stock if it goes down in
binomial pricing model, d .

DM Chapter 10 & 11- Binomial Option Pricing

u  e 
r  h  h
1.

2. d  e r  h h

DM Chapter 10 & 11- Binomial Option Pricing

## The value of the option at a node for:

1. An American call;
2. An American put.

DM Chapter 10 & 11- Binomial Option Pricing

## 2. Put  S , K , t   max  K  S , Pu p*  Pd 1  p* 

DM Chapter 12- The Black Scholes Formula

## The assumptions of Black-Scholes formula

DM Chapter 12- The Black Scholes Formula

## 1. The continuously compounded returns on the stock are normally

distributed and independent over time;
2. The volatility of continuously compounded return is known and
constant;
3. The future dividends are known, either as a dollar amount or as a
fixed dividend yield;
4. The risk-free rate is known and constant;
5. There are no transaction costs or taxes;
6. It is possible to short-sell costlessly and borrow at the risk-free rate.

DM Chapter 12- The Black Scholes Formula

## Call option premium under the assumption of Black-Scholes Framework,

given that the stock pays dividend as a fixed dividend yield

DM Chapter 12- The Black Scholes Formula

C  Se T N  d1   Ke rT N  d2 

where

 Se T  1
ln   rT    2
1. d1 
 Ke  2
 T
2. d2  d1   T

DM Chapter 14 & 22- Exotic Options

## CallOnPut  PutOnPut  BSPut  xe rt1

DM Chapter 14 & 22- Exotic Options

## 1. Call option with strike price K1 and trigger price K 2 ;

2. Put option with strike price K1 and trigger price K 2 .

DM Chapter 14 & 22- Exotic Options

## 1. Call  Se T N  d1   K1e rT N  d2 

2. Put  K1e rT N  d2   Se T N  d1 
where

  r    0.5 2  T
S
ln
K2
1. d1 
 T
2. d2  d1   T

DM Chapter 19- Monte Carlo Valuation

 1 2
      h  hZ  n 
Snh  S n1h e  2 
or

 1 2  1 n 
     T  h 
 2   n
 Z i 
ST  S0e i 1 

DM Chapter 19- Monte Carlo Valuation

## Monte Carlo Valuation of plain vanilla options:

1. Call option;
2. Put option.

DM Chapter 19- Monte Carlo Valuation

1 N   r   12 2 h  hZ  i  
1. C e  rT
 max  S0e 
 K , 0
N i 1  
1 N   1 2
 r     h  hZ  i  
2. Pe  rT
 max  K  S0e  2 
, 0
N i 1  

DM Chapter 20 & 21- Brownian Motion, Itô’s Lemma