Option Contracts, Participants, Strategies, and Pricing

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In this course, we'll address the basics of option pricing. We'll provide a short review of discounting and future value and also discuss the Law of No-arbitrage, along with examples that illustrate its utility in pricing.

We will also define two basic option types, call and puts, and explain their payoffs. The six key inputs that determine option prices will be examined and the relationship of each input's effect on the call price and put price will be evaluated. The survey of the types of participants in options markets will also be discussed. The trading strategies used by these participants will be presented, both with single options, as well as with combinations of options. Next, option pricing will be analyzed in detail. First, a binomial model is used to compute the price of an option in discrete time. The underlying assumption of no-arbitrage is addressed again as the option is priced going backward in time, from option expiration to the present. The hedge ratio at each node is calculated to emphasize the notion of replication. Then the Black Scholes formula will be derived, along with explanations of the assumptions underlying the model. The mathematics are carefully interpreted at each step, resulting in an intuitive description of the partial derivatives, or Greek sensitivities, within the Black Scholes partial differential equation.

What you will learn

• Provide the foundation of handling cash flows and implied forward rates from no-arbitrage.

• Define the payoffs of vanilla calls and puts, and the six factors affecting their pricing.

• Identify market participants and illustrate the option strategies they use.

• Derive vanilla option prices using binomial trees, Black Scholes, and Monte Carlo simulations.

• Provide intuition both in the Black Scholes partial differential equation and the formula.

Skills you learn

• Derivatives
• Trading Strategy
• Arbitrage
• Modern Greek

Syllabus

Module 01: The Basics

Module 02: Option Contracts

Module 03: Participants and Strategies

Module 04: Option Pricing

Module 05: Review

Auto Summary

Explore the fundamentals of option pricing with this foundational course in Business & Management, taught by edX. Delve into call and put options, key pricing inputs, market participants, and trading strategies. Learn through detailed analysis using binomial models and the Black Scholes formula, ensuring a comprehensive understanding. Perfect for beginners, this course offers a starter subscription option.