OPTIONS PRICING 2

PROGRAM OUTLINE

In 1973 Black-Scholes wrote a paper on option valuation, centred on some tricky mathematics. In particular, this paper left many academics baffled over ‘stochastic processes’ and ‘random walks’.

Later, Cox, Ross and Rubenstein came up with their own explanation by creating ‘trees’ that visually represented this idea of random walks. Combined with he Black-Scholes idea of ‘risk-neutral valuation’, this led to an option valuation model far more applicable than Black-Scholes.

We will build up to the famous Black-Scholes equation using cashflows and greeks from earlier classes in this series. We will avoid using unnecessary mathematics unlike many academic text books. We will investigate the Black-Scholes pricing formula and correct misstatements people often make like ‘N(d1) is delta’ and ‘at-the-money options have a 50 delta’

PRE-REQUISTES

An awareness of options pricing, preferably via a course like Option Pricing 1, part of this series or classes.

CONTENT

Binomial modelling
• Does option valuation require probabilities?
• Risk-neutral valuation and risk-neutral portfolios
• Replicating portfolios

Black-Scholes pricing formula
• Cashflows on a hedged option trade; costs and benefits
• Applying the formula
• The ‘0.4 rule – pricing options in our head
• Correcting myths about delta: N(d1) and 59 delta options

COURSE DURATION

This class is offered in four separate half-day units that run concurrently. These can be taken separately but there are themes that run through the units.

WHO SHOULD TAKE THIS COURSE?

Aimed at staff and clients who want to understand the inner working of option valuation. It is not necessarily just for those who are actually involved in valuation in practice

MODULES

These courses are included in this module

EXOTIC DERIVATIVES

To understand the reasons for using exotic over standard options and gain insight into why exotics are sometimes more expensive or cheaper.

Understand why investors may choose to buy various types of structured products. Understand how a bank provides products with structured payoffs.

INTEREST RATES SWAPS AND SWAPTIONS

Understand items on swap term sheets. Learn what drives value of a swap as the rates market moves. How to use swaps to hedge cashflow, risk or mark-to-market risk. Then look at the swaptions markets as a direct extension of what has already has been done.

CREDIT DERIVATIVES

To understand the basic products and the drivers of value in the credit world.

FX OPTIONS

To apply derivatives theory and knowledge to the FX markets.

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