Properties of Stock Options

Notation
 C : American Call option
 c : European call price
option price  P : American Put option
 p : European put
price
option price  ST :Stock price at option
 S0 : Stock price
maturity
today  D : Present value of
 K : Strike price dividends during option’s
 T : Life of option life
 : Volatility of stock  r : Risk-free rate for

price maturity T with cont comp

Effect of Variables on Option
Pricing (Table 9.1, page 202)

Variable c p C P
S0 + – + –
K – +? – +
T ? + +
 + + + +
r + – + –
D – + – +
American vs European Options

An American option is worth at

least as much as the
corresponding European option
Cc
Pp
Upper Bounds for Call

Call option can never be worth

more than stock
S0  c, C
Example, S0 = 100, c = 110 ?
Upper Bounds for Put
American Put option can never be worth
more than strike price
K P
Example, K = 50, p = 55 ?

European Put option can never be worth

more than present value of strike price
Ke–rT  p
Example, K = 50, Ke–rT = 48, p = 49 ?
Lower Bound for European
Call Option Prices; No
Dividends

c  max(S0 – Ke–rT, 0)
Calls: An Arbitrage
Opportunity?
Suppose that
c=3 S0 = 20
T=1 r = 10%
K = 18 D=0

Is there an arbitrage opportunity?

Lower Bound for European Call
Option Prices; No Dividends
Amore formal argument,
Consider two portfolio
◦ Portfolio A: (One European call option +
cash amount of Ke–rT)
◦ Portfolio B: (One share)
Lower Bound for European Put
Prices; No Dividends

p  max(Ke -rT–S0, 0)
Puts: An Arbitrage
Opportunity?

Suppose that
p=1 S0 = 37
T = 0.5 r =5%
K = 40 D =0
Is there an arbitrage
opportunity?
Lower Bound for European Put
Option Prices; No Dividends
Amore formal argument,
Consider two portfolio
◦ Portfolio C: (One European put option +
One share)
◦ Portfolio D: (cash amount of Ke–rT)
Put-Call Parity; No Dividends
 Consider the following 2 portfolios:
◦ Portfolio A: European call on a stock + PV of the
strike price in cash
◦ Portfolio C: European put on the stock + the
stock
 Both are worth max(ST , K ) at the maturity of the
options
 They must therefore be worth the same today. This

means that c + Ke -rT = p + S0

Arbitrage Opportunities
Suppose that
c =3 S0 = 31
T = 0.25 r = 10%
K = 30 D=0
What are the arbitrage
possibilities when
p = 2.25 ?
p=1?