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42 Cards in this Set

  • Front
  • Back
What is the importance of the BSOPM?
we have a good understanding of what options should sell for.
What equation is it related to in physics?
Heat transfer equation
What is the equation for the Black Scholes option pricing model?
What happens to the value of a call option if the strike price decreases?
the call option premium goes up.
What happens to the value of a call time until expiration increases
for both puts and calls the premium increases
How does the current stock price affect call premium?
the higher the stock price the more a given call option is worth.
How does the volatility of the stock returns affect the call premium?
the greater the price volatility of an asset the greater the call premium
What is sigma
It is a volatiltiy estimate
Wjat is the annualized standard deviation?
it is the volatilty used in Black Scholes
Past volatiltiy is called?
historical, statistical, or realized volatility
Does the BSOPM adjust for cash dividends?
no listed stock options are not adjusted for cash dividends.
but dividends indirectly decrease call prices.
What happens to the stock price on the ex dividend date?
the ex dividend date is two days before the date of record, you must buy before this date to get the dividend. The stock price decreases on this day.
What happens to the call price when the riskless interest rate increases?
The higher the interest rate the higher the option premium
What is the assumption in bsopm regarding the payment of dividends?
that it pays no dividends
Why do we use the natural logirithm in black scholes?
it assumes continous compounding of the interest rate
How do you plug in a stock that pays a dividend into the black scholes?
you subtract the pv of the dividend from the current stock price and use that for s
pv of div=div*(e^-rt)
What is the Merton model extension?
it accounts for dividends as a continous stream rather than a discrete payment
it produces the same exact result as pv of div in B/S
Does the BSOPM value europeon or american options?
Europeon-can only be exercised on the expiration date
What about dividends paid after the expiration date?
They do not affect the price they are immaterial
What does the BSOPM assume about market efficiency?
it assumes mkt informationally efficient, meaning people cannot predict the direction of the market or a stock.
Put/call parity states that regardless of whether you are bullish or bearish you will...
agree on the option premium. Premiums are not affected by expected return on the stock
What are the assumptiona about transaction costs?
no transaction costs
What are the assumptions about interest rates?
that they remain flat/constant
What is the assumption about the distribution of stock prices?
that they are normally distributed
What is the value of an call option?
the difference between the expected benefit from acquiring the stock outright and paying the exercise price on expiration day
SN(d1) means
cash inflow- weighted expected stock price

N(d1)is the prob of being in the money adjusted for how much in the money
K(e^-rt)n(d2) means
cash outflow-time value of money adjusted for expected payment @ exercise
N(d2)prob of being in the money
What is implied volatiltity?
the value of sigma that causes model call premium to equal the actual call premium
How do you solve for implied volatility?
put in the call premium and back it out
What does implied volatilty tell us?
it tells us what is going to happen to the market (what the market thinks the volatility will be until expiration) only if we think the call premium is correct
What is the difference between historical versus implied volatility?
historical is what has happened and implied is what the model implies the volatility will be
Is there a relationship between historical volatilty and implied volatility
yes an ex ante (before the fact) and a ex post(after the fact)
What did strong and dickerson find about implied volatility?
the current level of implied volatility contains both an ex post component and an ex ante component
Can you compare the dollar cost of two different options?
no their are to many variables that can differ
What is a volatiltiy smile?
it is a contradiction to the Black Scholes which assumes a constant volatility across all strike prices
Why the term smile?
because of the curve you get when plotting implied volatility against strike price
How can the Black Scholes be used to find the price of put options? equation?
With put/call parity
What is the relationship between S, K, T, Std Dev, and R (Risk free rate)and the price of a put?
Stock Price-negative/inverse relationship
k-positive relationship
t-positive relationship
std dev-positive (want more volatility
How is B/S at pricing deep in the money or deep out of the money
it will misprice them
how is B/S at pricing options that have very high or low volatility
it will misprice it is at its best with moderate volatility
How is B/S at pricing options that only have a few days to expiration?
it will misprice
When does BSOPM have the best accuracy?
for options that are at the money and within the next striking price on either side of the stock price.