Pricing index options

sunandaC

New member
Under the assumptions of the Black–Scholes options pricing model, index options should be valued in the same way as ordinary options on common stock.

The assumption is that investors can costlessly purchase the underlying stocks in the exact amount necessary to replicate the index; that is, stocks are infinitely divisible and that the index follows a diffusion process such that the continuously compounded returns distribution of the index is normally distributed. To use the Black–Scholes formula for index options, we must however make adjustments for the dividend payments received on the index stocks.

If the dividend payment is sufficiently smooth, this merely involves replacing the current index value S in the model with Se-qT where q is the annual dividend yield and T is the time to expiration in years.

The Black-Scholes formula is so commonly used that it comes programmed into most calculators and spreadsheets. Hence it is not necessary to memorize the formula. One only needs to know how to use it.

Note: The pricing models discussed in this chapter give an approximate idea about the true options price. However the price observed in the market is the outcome of the price–discovery mechanism (demand–supply principle) and may differ from the so-called true price.
 

rosemarry2

MP Guru
Under the assumptions of the Black–Scholes options pricing model, index options should be valued in the same way as ordinary options on common stock.

The assumption is that investors can costlessly purchase the underlying stocks in the exact amount necessary to replicate the index; that is, stocks are infinitely divisible and that the index follows a diffusion process such that the continuously compounded returns distribution of the index is normally distributed. To use the Black–Scholes formula for index options, we must however make adjustments for the dividend payments received on the index stocks.

If the dividend payment is sufficiently smooth, this merely involves replacing the current index value S in the model with Se-qT where q is the annual dividend yield and T is the time to expiration in years.

The Black-Scholes formula is so commonly used that it comes programmed into most calculators and spreadsheets. Hence it is not necessary to memorize the formula. One only needs to know how to use it.

Note: The pricing models discussed in this chapter give an approximate idea about the true options price. However the price observed in the market is the outcome of the price–discovery mechanism (demand–supply principle) and may differ from the so-called true price.

Hi buddy,

Here I am sharing Index Options - Introduction, Essential Terms and Definitions, so please download and check it.
 

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