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Ff options can only be priced because they can be replicated, why do we need them? - Assignment Example
Finance & Accounting
Pages 4 (1004 words)
Date If options can only be priced because they can be replicated, why do we need them? Introduction Pricing of options is conducted on myriads of instruments where the achievement of dynamic replicating is closer to impossible…
Although derivatives are technically conspicuous reason being they can undergo replication using basic financial instruments, they are still the tools that provide those who participate in the market to full of risk to manage the particular risks. Nature of options dynamic replication Dynamic hedging of options is never conducted even with the market makers(Lussier & PareI, 2004). In nature, options are hard to deal with due to the technicality of the language used to describe the tools. The difference between dynamic and static hedging is small since hedging is only realized on minor positions. The risks taken by either parties are very different and highly distinguished, those with the buyer and distinct from those with the writer of the options hence asymmetry in the payoffs making it very hard for dynamic replication. Options also have the tendency of changing their character in a dynamically replicative way depending on whether they are in the money or out of the money. Dependent on this, is the fact that the value of out of the money option is the probability that at expiry the said option will have some value without dynamically replicating (Lussier & PareI, 2004). Dynamic replication assumes a constant movement of asset prices while the real prices of the assets can move non-constantly. ...
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