CHAPTER 25Pricing European Options
Aims
- To adapt the standard Black–Scholes formula to price European options on stocks that pay dividends.
- To price European foreign currency options and futures options.
- To demonstrate the links between pricing formulas for European options on dividend paying stocks, foreign currency options and options on futures contracts.
- To examine the links between the put–call parity relationship for European options on dividend paying stocks, on foreign currency and on futures contracts.
The standard Black–Scholes formulas for call and put options on a non-dividend paying stock are:
25.1 WHAT DO N(d1) AND N(d2) REPRESENT?
Even without detailed proofs, we can get some insight into the interpretation of these two concepts. The term 
is the probability that the call option will be exercised (i.e. 
) in a risk-neutral world. If the call option is exercised then the holder of the call pays K, so the expected cash outflow at T is 
, with expected present value 
. The ...
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