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The Black-Scholes-Merton Model
The Black-Scholes-Merton Model
Model
Chapter 13
Options, Futures, and Other Derivatives, 7 th Edition, Copyright © John C. Hull 2008 2
The Lognormal Property
(Equations 13.2 and 13.3, page 278)
2
or
2
ln ST ln S 0
T, T
2
2
Since the logarithm of ST is normal, ST is
lognormally distributed
E ( ST ) S0 e T
2 2 T 2T
var ( ST ) S0 e (e 1)
Options, Futures, and Other
Derivatives, 7th Edition, Copyright ©
John C. Hull 2008
Continuously Compounded
ReturnEquations 13.6 and 13.7), page 279)
If x is the continuously
compounded return
ST S 0 e xT
1 ST
x = ln
T S0
2 2
x ,
2 T
Options, Futures, and Other
Derivatives, 7th Edition, Copyright ©
John C. Hull 2008 5
The Expected Return
The expected value of the stock price is S0eT
The expected return on the stock is
– not
This is because
ln[ E ( ST / S 0 )] and E[ln(ST / S 0 )]
are not the same
Options, Futures, and Other Derivatives, 7 th Edition, Copyright © John C. Hull 2008 6
and −
ƒ = S – K e–r (T – t )
c S 0 N (d1 ) K e rT N (d 2 )
p K e rT N (d 2 ) S 0 N (d1 )
ln( S 0 / K ) (r 2 / 2)T
where d1
T
2
ln( S 0 / K ) (r / 2)T
d2 d1 T
T
Options, Futures, and Other
Derivatives, 7th Edition, Copyright ©
John C. Hull 2008 17
The N(x) Function
N(x) is the probability that a normally
distributed variable with a mean of zero and
a standard deviation of 1 is less than x
See tables at the end of the book
Payoff is ST – K
Expected payoff in a risk-neutral world
is S0erT – K
Present value of expected payoff is