Option Valuation

These flashcards cover fundamental concepts related to option valuation, including intrinsic value, time value, determinants of option value, and the Black-Scholes pricing model.

Intrinsic Value

Stock price minus exercise price, or profit that could be attained by immediate exercise of in-the-money call option.

Time Value

The difference between an option’s price and intrinsic value.

Determinants of Option Value

Factors that affect the value of an option, including stock price, exercise price, volatility of price, time to expiration, interest rate, and dividend rate.

Black-Scholes Pricing Formula

A mathematical model for pricing an option, represented as Co = Soe^(rT)N(d₁) - Xe^(-rT)N(d₂).

N(d)

Probability of a random draw being less than d, where d represents certain calculated values in the Black-Scholes model.

Implied Volatility

Standard deviation of stock returns consistent with option’s market value.

Put-Call Parity Relationship

Represents the relationship between put and call prices, defined as C + PV(X) = P + S0.

Exercise Price

The price at which an option can be exercised.

Volatility (σ)

A measure of the price fluctuations of an underlying asset.

Risk-free Interest Rate (r)

The theoretical return on an investment with zero risk, often used in the Black-Scholes model.