OPTION PRICING

Finance - Option Pricing



Finance - Option Pricing

Question 1

The quote above by Hakansson's so-called paradox is a remarkable question, nevertheless, the more one think regarding it, the less it will become to the paradox to the intelligent financial analyst No doubt it is true as the derivative true value has an ability to payoff create novel patterns relation to the one which would shaped with the underlying assets. Take another way, the value of divertive considered as their ability to be a non redundant due to the fact that if anyone can replicate perfectly the payoff then for them it is not actually of any economic value apart from the fact that may be or can be hedge entirely.

However, it seen justifiable when derivative trade at a price where everything is equal with a price proportional to the risk which is basis, here, one will expects to hedge the security in order to mitigate the risk. For instance, one person agrees to take the ton of basis risk, it is obvious that there will be a market displacement which is called CDS selling or GM correlation trade , one can sell that security at premium in order to compensate the risk. Hence, the entire risk should be compensated in order to make proper sense. Yet, although the derivative value is heavily tied to the dynamic replication concept, this does not mean that the price of the options can be only be priced due to the fact that replicated can be done said by Taleb. It should be mention that Taleb do not make assert themselves and also he signify that he has 100x which is as strong as a grasp of derivative than anyone). Moreover, if someone moves from the security which can be replicated, the basis risk will increase along with the premium which is expected by the investors is due to this basis risk.

For the full simulation ("full replication"), all components of the index in the corresponding weighting are held in the Fund. The stock market index is physically replicated. In this replication method, the assets of the ETF is in the values ??(eg shares) of the underlying index. The shares will be purchased according to their weighting in the index. For a complete replica of indices like the S & P 500-stock index contains many individual values, practically almost impossible. So it may happen that the stock market index has values, which - at least temporarily - are not freely tradable. A high number of shares - such as the S & P 500 or the Nikkei 225 index - the index lead to reproduction also significantly higher transaction costs.

In conclusion, we can say that assuming theoretical value with continuous rebalancing is first and occasionally can be neglected. It is necessary to keep track on the ton of thing in order to determine the worth of derivative like liquidity risk, basis risk and supply/demand factors. Furthermore, investors pay in real term and sense for ...