Beruflich Dokumente
Kultur Dokumente
Derivatives are the dynamite for financial crises and the fuse-
Famous Calamities
1994: Orange County, CA: losses of $1.7 billion
1995: Barings Bank: losses of $1.5 billion
1998: LongTermCapitalManagement (LTCM) hedge fund,
Fundamental Questions:
What premium should the buyer (`holder`) pay to the
the difference between the stock price on July 15, 2011 and the
strike (as long the stock price is higher than the strike.)
So if Apple is worth $400 then, this option would pay $40. If the
stock is below $360 at maturity, the contract expires worthless. .
....
So, what would you pay to hold this contract?
What would you want for it if you were the writer?
I.e., what is a fair price for it?
Or mathematical analysis:
dS
dt dX
S
where
S = price of underlying
dt = infinitesimal time period
dS= change in S over period dt
dX = random variable with N(0,dt)
= volatility of S
= average return of S (`drift)
V - *S
the portfolio can be made riskless, i.e. have a
constant return regardless of what happens to S.
( turns out to be =dV/dS and it is constantly
changing ->strategy of dynamic hedging)
This allows us to compare the portfolio to a riskless
asset and be priced accordingly.
This eventually implies that V has to satisfy the
dynamic condition given by the PDE.
V 1 2 2 V
V
S
rS
rV
0
2
t 2
S
S
2
V 2 2 2V V
+1=2 S +rS rV =0
t S2 S
V =value of derivative
S =price of the underlying
r =riskless interest rat
=volatility
t =time
V 2 2 2V V
+1=2 S +rS rV =0
t S2 S
V 2 22V V
+1=2 S +rS rV =0
t S2 S
V 2 22V V
+1=2 S +rS rV =0
t S2 S
V 2 22V V
+1=2 S +rS rV =0
t S2 S
rt
C SN (d1 ) Ee N (d 2 )
Where N is the cumulative distribution
or other programs
E=360
r=1%
t=5.5 months
and =27%
$18.60
$343 to $360.
What happens to the value of the option?
Yes, it goes up. How much?
A: from $18.60 to $27.00!
Thats an almost 50% gain!
Thats called Leverage, and Thats the power of
options!
closed formulas have been found. (Barrier-options, Lookbackoptions, Cash-or-Nothing Options). Those are accessible on the
web at sitmo.com
Others need numerical PDE-methods.
Or entirely different methods:
Cox-Ross-Rubinstein Binomial Trees (1979)
The Monte-Carlo-Method
Assume =r.
The MonteCarlo-Method
Histogram
3500
3000
2500
2000
1500
1000
500
0
= 21.30
100
200
payoff
300
400
500