CHAPTER 9Option Boundary Conditions and Fundamental Price Relations

In this chapter, we begin our analysis of option pricing by examining the boundary conditions for minimum prices of options, the price relationships between options with different exercise prices and times to expiration, and how dividends influence the price of an option. In our analysis, we will examine each relationship separately. In Chapter 10, we will integrate many of the relationships by deriving the binomial option‐pricing model.

To facilitate our discussion, the symbols for the call premium (C) and put premium (P) will be expressed (when it is helpful) in the following functional form: C = C(X, T) or P = P(X, T). Since some relations are applicable for European options, ...

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