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Apr 12

What You Need to Know About Option as A Beginner Part I

Posted by bo at 09:01 | Others | Comments(0) | Reads(5158)
My third introductory article.

Knowledge about Option pricing is essential prior investing in those.  If you are a novice, then you are in the right spot. Here in this article, you could get a basic knowledge about the Option, its type & pricing etc.

Basic definition of Option
In order to understand about Option pricing, you need know about the option first. Option is nothing but an official contract, between a buyer and a seller, that gives the buyer of the option the right, but not the obligation, to buy or sell a specified asset on or before the option’s expiration date, at an agreed price (the strike price).

Types (Call and Put)
A “Call option” gives the buyer of the option the right to buy the underlying asset at the strike price whereas the “Put option” gives the option to sell the underlying asset at the strike price. If the buyer chooses to exercise this right, the seller is obliged to sell or buy the asset at the agreed price. The buyer may choose not to exercise the right and let it expire. The underlying asset can be a piece of property, a security (stock or bond), or a derivative instrument, such as a futures contract.

Valuation models
The value of an option can be estimated using a variety of quantitative techniques based on the concept of risk neutral pricing and using stochastic calculus. The most basic model is the Black-Scholes model. These models are implemented using a variety of numerical techniques. In general, standard option valuation models depend on the following factors:
•  The current market price of the underlying security,
•  the strike price of the option, particularly in relation to the current market price of the underlying asset (in the money vs. out of the money),
•  the time to expiration together with any restrictions on when exercise may occur, and
•  an estimate of the future volatility of the underlying security's price over the life of the option.

Check Varieties of programming codes on option valuation for implementation.

To be continued...


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