Exam 16: Understanding Options

If the stock price follows a random walk successive price changes are statistically independent. If σ2 is the variance of daily price change, and there are t days until expiration, the variance of the cumulative price changes is:

All things being equal, the closer an option gets to expiration, the lower the option price.

Put-call parity can be used to show:

If you write a put option, you acquire the right to buy stock at a fixed strike price.

The writer of a put option loses if the stock price declines.

For an European option: Value of call + PV(exercise price) = Value of put + share price.

Options written on volatile assets are worth more than options written on safer assets.