17.4 VALUATION OF EUROPEAN STOCK INDEX OPTIONS

In valuing index futures in Chapter 5, we assumed that the index could be treated as an asset paying a known yield. In valuing index options, we make similar assumptions. This means that equations (17.1) and (17.2) provide a lower bound for European index options; equation (17.3) is the put–call parity result for European index options; equations (17.4) and (17.5) can be used to value European options on an index; and the binomial tree approach can be used for American options. In all cases, S0 is equal to the current value of the index, σ is equal to the volatility of the index, and q is equal to the average annualized dividend yield on the index during the life of the option expressed with continuous ...

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