Chapter 19. Options and Option Portfolios

In the last three decades, derivative securities—meaning securities whose prices depend on the prices of other securities or assets—have become one of the most important segments of the financial markets. They are used for both speculating and hedging, but a key use is to create portfolios with characteristics that meet the wide range of needs and tastes of the millions of participants in the financial markets.

Options constitute one of the most important classes of derivative securities, and it is now recognized that many real life problems have "option-like characteristics." In this chapter, we will develop several models to estimate the prices and the Greeks for options. We will also demonstrate some of their properties and will develop a model for a portfolio of stocks and options that can be used to study various option-trading strategies.

Review of Theory and Concepts

Some of the theory and mathematics related to the pricing of options is fairly complex and beyond the scope of this book. For details on them, you can refer to any of the standard books on derivatives. An excellent book on the subject is Options, Futures, and Other Derivatives by John C. Hull (6th edition); some of the material in this chapter parallels his presentations.

OPTION BASICS AND TERMINOLOGY

Options can be created on almost any asset, and they are now actively traded on a wide range of assets such as stocks, bonds, and currencies. It is easiest to learn the basics ...

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