By P. Glabadanidis
Absence of Arbitrage Valuation provides a unified asset pricing process via absence of arbitrage and applies this framework to such disparate fields as mounted source of revenue safeguard pricing, foreign currency spots, and ahead charges.
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Additional info for Absence of Arbitrage Valuation: A Unified Framework for Pricing Assets and Securities
This prespeciﬁed price at which we can acquire the underlying stock is usually called the exercise price or the strike price. Conversely, a put option on a stock entitles the owner to sell the stock at the strike price at or before maturity of the option. 1 A stock option is a legal contract that is essentially a side bet between the buyer and the seller. It has several key quantities that drive the value of the option, namely, the exercise price or the strike price, the time until maturity, and the exercise style.
An arbitrage strategy here would involve selling short the risky underlying security and investing the proceeds in the risk-free bond. We are guaranteed to make a proﬁt in both states of the world and, once again, we are not risking anything. Therefore, this inequality is also untenable. The only viable arbitrage-free condition for the parameters of the binomial option pricing model is the following: U > R > D. Proceeding under the assumption that all our binomial option pricing models will have to fulﬁll the above condition, we continue with the setup of a replicating strategy in this more general case.
Investing in a straddle volatility bet (buying 1 call and 1 put) will cost us $36. 67 + $26. 67 = $63. 34. Armed with the option replicating portfolio, it is easy to see how useful it can be for risk-management and hedging purposes. If an investor owns an option and needs to unload the entire risk of the option, then all that she needs to do is to sell the underlying replicating portfolio. The remaining position will be risk-free and will yield risk-free rates of return. In theory, we can also use the expected NPV rule to ﬁgure out the price of an option.
Absence of Arbitrage Valuation: A Unified Framework for Pricing Assets and Securities by P. Glabadanidis