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3026 Words Mar 27th, 2013 13 Pages
BEA3001 Financial Management 2012-2013

Option Pricing
Dr Bill Peng, CFA

Today
• Describe the basic characteristics of financial options • Develop the Binomial Option Pricing Model • Discuss the Put-Call Parity theorem • Introduce and apply Black-Scholes Option Pricing Model

BP

BEA3001 Financial Management

2

Coursework Test 1 Directions
• Reminder: CW Test 2 [4pm Wed 20th Mar 2013] • CW Test 1: 6pm on Monday 26th November • Students entitled to extra time: STC/C • Surnames starting with letters “A” to “K” (inclusive): Amory Moot Room • Surnames starting with letters “L” to “W” (inclusive): STC/A • Surnames starting with letters “X” to “Z” (inclusive): STC/B
BP BEA3001 Financial Management 3

Coursework Test 1
…show more content…
• Risk is a “two-way” street: upside potential vs. downside risk • An option is an agreement giving the buyer of the option the right, but not the obligation, to buy or sell a specific quantity of something (e.g., shares in a company, a foreign currency or a commodity) at a known or determinable price within a stated period • Options offer a choice between • Exercising your right to buy or sell at a pre-determined price (known as the exercise price or strike price), and • Not exercising this right: allowing the option to lapse (abandoning the option)
BP BEA3001 Financial Management 6

What is an Option? Cont’d
• An option which is not used is either discarded, or possibly, sold to somebody else who might find it valuable, if the rules allow this • Options can be used to provide protection against an investment’s downside, and at the same time, take advantage of its upside potential • Option is the right to do something, but NOT the obligation • In this lecture we focus on the right to buy or sell listed company shares • An option is an enforceable contract: not free – it is valuable
BP BEA3001 Financial Management 7

Option Terminology
• The owner (buyer) of an equity call option has the right (but not the obligation) to buy a specific quantity of

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