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American and European put option

American and European put option. KINDA SUMLAJI. Option Style. The most popular options are either European or American A European option may be exercised only at the expiration date of the option. An American option may be exercised at any time before the expiry date . Put Option.

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American and European put option

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  1. American and European put option KINDA SUMLAJI

  2. Option Style • The most popular options are either European or American • A European option may be exercised only at the expiration date of the option. • An American option may be exercised at any time before the expiry date.

  3. Put Option • Contract between two parties to exchange an asset, at a specified price (thestrike K), by a predetermined date (theexpiry or maturity T). The buyer of the put, has the right to sell the asset at the strike price by the future date, while the seller of the put, has to buy the asset at the strike price if the buyer exercises the option. • Payoff at maturity

  4. Put Option • If ST < , then the option will be exercised, the holder of this option will buy the underlying stock at a price of ST and exercise his right to sell it to the writer at the strike price of K, to make a profit of • If ST > , In this case, exercising the right to sell the underlying asset would result in a loss. • If the option is not exercised by maturity, it expires worthless.

  5. Option’s parameters

  6. Option Pricing • Black-Scholes Model

  7. Option Pricing • Binomial options pricing model • Valuation is performed iteratively, starting at each of the final nodes, and then working backwards through the tree towards the first node (valuation date). The value computed at each stage is the value of the option at that point in time. • Option valuation using this method is, as described, a three-step process: • price tree generation, • calculation of option value at each final node, • Sequential calculation of the option value at each preceding node.

  8. Binomial options pricing model • STEP 1: Create the binomial price tree

  9. Binomial options pricing model • STEP 2: Find Option value at each final node At each final node of the tree, the option value is equal to:

  10. Binomial options pricing model • STEP 3: Find Option value at earlier nodes

  11. Binomial options pricing model • The Cox-Ross-Rubenstein model • Black-Scholes smoothing

  12. Example

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