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Finance and Accounting : Option Pricing - Essay Example
Finance & Accounting
Pages 12 (3012 words)
Option Pricing Name: Institution: Subject: Date: Option Pricing An option is defined as a right to buy or sell a specific stock, debt, currency or even an index or a commodity, at a certain amount of money (Strike price) within a stipulated period of time…
The loss that amounts is in the loss of cash or amount paid for the option. Determinants of an option are stated as stock price, volatility, strike price, risk free (short term) interest rate and time to the expiration. The contract in this case, is called the option contract (Don, 2004, 142). Options are used by holders for leverage or for protection. The leverage function helps the holder to control the shares bought for a portion what they would have cost. On the other hand, protection measures are adopted when the holder wants to guard against price fluctuations. He enters in to a contract with the rights to acquire the stock for a fixed period and specific price. The contracts in either case should be highly observed and monitored for efficient outcomes. The methods used in pricing options have been applied for years and can only be effective if the worth of the option is achieved. This is determined by the probability that on the expiration, the option price will be on a substantial amount of money. Any holder of an option expects a gain on his underlying asset to attain the worth of holding for the time given. The Black Scholes and the Binomial method are the elaborated on below in determining the true worth of an option. The Black Scholes Model: This model dates back in the twentieth century in its application. ...
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