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Options for Volatile Markets: Managing Volatility and Protecting Against Catastrophic Risk, Second Edition by Lawrence G. McMillan, Richard Lehman

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CHAPTER 2

Option Pricing and Valuation

Understanding what options are and how they work is certainly a prerequisite to trading them. But the real key to trading options or utilizing them to hedge is in understanding how they are valued. The price relationship between options and their underlying securities, between options and other options, or between options and time, volatility, or other factors, is not always intuitive, nor is it necessarily linear. Given the leverage involved in options, even minor pricing discrepancies or misunderstandings can magnify themselves into substantial amounts of money.

This chapter describes the factors that affect option prices, how much they affect them, and in what direction. To understand each of these factors ...

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