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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?

C=SN(d1)K(e^rt)N(d2)


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?

Europeoncan 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 outflowtime 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
P=K(e^rt)N(d2)SN(d1) 

What is the relationship between S, K, T, Std Dev, and R (Risk free rate)and the price of a put?

Stock Pricenegative/inverse relationship
kpositive relationship tpositive relationship std devpositive (want more volatility Rnegative/inverse 

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.
