Option Pricing Models

Option Pricing Models

1. One-period binomial model (for a European call option)

   • Formula for C
     • Any intermediate steps (derivation)?
   • Formula for p
     • Value for p often given
   • Set-up
     • Necessary variables and formulas?
   • Arbitrage opp?

2. Prior assumptions?

3. Two-period binomial model

   • Formula for C = a little more complex
   • Recombining and non-recombining trees
     • Manipulating a non-recombining tree to make it recombining
     • Potential pathways
   • Inclusion of dividends
   • American call option?
   • Comparing the prices of call options: European vs. European w/dividend vs. American w/dividend

4. Multi-period binomial model

   • Formula for C for three-period model?
   • Derivation of n-period model
     • Complex, but largely intuitive
     • Simplify by removing any out-of-the-money outcomes

5. Black-Scholes model

   • Very unlikely to be examined?!