Questions tagged [black-scholes]
Black-Scholes is a mathematical model used for pricing options.
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Black Scholes theta as function of time to maturity
I would like to understand why the Black and Scholes greek letter theta for european call option behave in the following way:
as time to maturity is far away (right part of the x-axis in the the ...
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Black-Scholes model - Calibration of the risk-free rate
I know there is a lot of content about this topic, but I have not seen a post which gives a satisfying answer to my problem.
I am trying to hedge a European call option with real market data under ...
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Asian Options-Change of Numeraire
Assume the risk-free bond $B_t$ and the stock $S_t$ follow the dynamics of the Black & Scholes model
without dividends (with interest rate r, stock drift $\mu$ and volatility $\sigma$).
Show that ...
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1answer
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Call Option on the Square of a Log-Nomral Asset
I'm working on a quant interview question from the book called Quant Job Interview Questions And Answers (by Mark Joshi and other authors).I cannot understand its answer well and really appreciate ...
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Black-Scholes equation Variational / Weak form
I am having difficulty deriving the weak formulation of the Black-Scholes Equation.
I have multiplied it with a test function phi and integrated over Omega. But results on the internet suggest ...
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Deriving implied volatility programmatically
I'm working on a project to calculate the value of options using Python. I'm using the Black-Scholes model, and I can get accurate results by plugging in a given ...
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Black-Scholes-Merton and alternatives as interpolation tools
This is a not very quantitative question, but is nevertheless related to quantitative methods in Finance.
I was reading the following paragraph from Hull's Options, Futures, and other Derivatives:
...
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Proving an Expectation
Assume the risk-free bond $B_t$ and the stock $S_t$ follow the dynamics of the Black & Scholes model without dividends. Consider the perpetual American put option with payoff $(K-S_\tau)^+$ when ...
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Proving a process is martingale under the Risk Neutral Measure
Show that for any $\lambda \in \Re$, the process $Y_{\lambda,t}$ defined as:
$$Y_{\lambda,t} = (S_t/S_0)^\lambda e^{-(r\lambda-\lambda(1-\lambda)\sigma^2/2)t}$$
is a martingale under the risk ...
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1answer
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Floating Strike Lookback Call Option
Assume the risk-free bond $B_t$ and the stock $S_t$ follow the dynamics of the Black & Scholes model
without dividends (with interest rate $r$, stock drift $\mu$ and volatility $\sigma$).
If $r=\...
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1answer
99 views
Different volatility surface ( Local vol, Stochastic vol etc.)
Despite many questions about local and stochastic volatility available on this forum, i still have a few doubts left. Essentially I am seeking validation whether I am interpreting things correctly.
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Black-Scholes delta of a barrier (knock-out or knock-in) option
I'm trying to calculate the Black-Scholes delta of a barrier option given the following information:
Whether it is knock-out or knock-in
Barrier price
Strike price, $X$
Current stock price, $S$
...
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Alternative derivation of Black Scholes by Merton
I am currently reading the Theory of Rational Option Pricing (1973) by Robert Merton. In the paper, I encountered a section under the title "An Alternative Derivation of the Black- Scholes Model". I ...
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Premium Adjusted Delta in fx market
Please explain the concept of premium Adjusted Delta in FX market. In EURUSD, why delta changes if premium currency is changed from USD to EUR and how this new delta is related to the old one with ...
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Possibility of delta greater than 1 [closed]
Can delta of an option be greater than 1? Please illustrate it with an example.
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Stochastic Volatility and Sticky Delta
"Stochastic volatility models can be thought of as sticky delta model. And Local volatility model as sticky Strike." Please help me understand how the author has reached this conclusion.
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Linear Or nonlinear Black Scholes Equation
I have been going through the analytical solutions of black scholes equation which transforms it to a heat equation.
$$u_{t}=\frac{1}{2}\sigma^{2}u_{xx}$$
Now if the volatility is constant , then its ...
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1answer
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some questions about pricing an asset or nothing put option with a strike price equal to St
I am working on a homework exercise where the aim is to price an asset or nothing put with K = St, offcourse the normal formula could be used St * N(-d1), but I was wondering if pricing the asset by ...
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Derivation of Call Delta from Black Scholes Model
How is call delta mathematically derived from Black Scholes Model (without approximation) ? Please help me understand each step mathematically. And how it is approximated to say that delta is the ...
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Asset return distribution
What is the basis for assumption that asset prices follow a log normal distribution? Then how is it transformed to say that asset return follows a normal distribution? How this relationship between ...
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1answer
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Intuitive explanation of why ITM options have low Time/Extrinsic Values?
While brushing up on my knowledge about the Greeks, I have been struggling coming up with an intuitive, probability-based explanation behind why not only Out-of-the-Money (OTM), but also In-the-Money (...
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1answer
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Delta hedging: theoretical value vs actual price
One way to derive the Black-Scholes PDE is via the Delta-hedging argument:
Suppose that $V_t = V(t, S_t)$, for some function $V: [0,T] \times \mathbb{R} \to \mathbb{R}$. We construct a portfolio by ...
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1answer
154 views
Calculate the price at time t=0
Assume the risk-free bond Bt and the stock St follow the dynamics of the Black & Scholes model
(with interest rate r, stock drift $\mu$ and volatility $\sigma$).
Calculate the price at time $t = ...
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Develop an option pricing equation by Ornstein Uhlenbeck process
I know that Black-Scholes equation is based that the Equity price has a Geometrical Brownian movement.
Can I develop from the same principles( now with transaction cost) that Black Scholes is ...
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Does an option need to be tradable for Black Scholes pricing formula to hold?
Given the classic Black-Scholes model, e.g.
$dS(t)/S(t)=rdt+\sigma dW^{\mathbb{Q}}(t)$ with $S(0)=S_0$ and
$dB(t)=rB(t)dt$ with $B(0)=1$,
whereby $r$ and $\sigma$ are constants and $\mathbb{Q}$ ...
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1answer
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How to derive Balck Scholes from the Binomial Model?
The book gives the following recipe, but no further details:
Do a Taylor series expansion of $$V = V(S,t)$$
Do a Taylor series expansion of $$V^{+} = V(u \cdot S, t + dt) \hspace{5mm}:\hspace{5 mm} u ...
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1answer
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Björks second $S$ process when introducing martingale measures
When Björk presents the Black-Scholes model and martingale measures he starts off with a process modeling the stock price calling it $S$ with some given dynamics w.r.t some measure $P$.
Then he ...
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2answers
90 views
Rate of return in Black-Scholes model
The rate of return of a stock is denoted $\frac{dS}{S dt}$ where $S$ is the solution to the SDE modeling the price of a stock. Can someone give an explanation of the rate of return and what it is ...
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2answers
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How to derive Black-Scholes equation with dividend?
Question: The Black-Scholes equation without dividend is given by
$$\frac{\partial V}{\partial t} + \frac{1}{2}\sigma^2S^2\frac{\partial^2 V}{\partial S^2} + rS \frac{\partial V}{\partial S} -rV = ...
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Is my derivation of Black-Scholes equation correct or am I missing something (eg assumption)?
Question: The following is my derivation of the Black-Scholes equation. Is it correct or am I missing some details (eg assumption)?
Let $V$ be value of an option.
Suppose value $\Pi$ of a portfolio ...
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2answers
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Understanding $N(d_1)$ and $N(d_2)$
Firstly, if the solution to geometric Brownian motion is $S_t = S_0 \exp((r-\sigma^2)t + \sigma W_t$ then if I have a payment that is not necessarily a full call option e.g. if the exercise price $K$ ...
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If the volatility is zero (i.e. σ=0), what is the call worth? After valuing the call, how to hedge the call (assuming you sold it)
Question: All Black-Scholes assumptions hold. Assume no dividends. The stock price is $100. The riskless interest rate is 5% per annum. Consider a one-year European call option struck at-the-money (i....
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Arbitrage free in a Black-Scholes/Poisson model
I am trying to solve the following exercise from Bjork's Arbitrage Theory in Continuous Time:
Consider a model for the stock market where the short rate of interest
$r$ is a deterministic ...
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Option pricing with definite integral
I would like to consider a slight generalisation of this question, which I recall here:
At date of maturity $T_2$ the holder of a financial contract will
obtain the amount: $$ \frac{1}{T_2−T_1}\...
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1answer
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Why and how is Implied volatility directly related to stock price but inversely related to strike price?
I know that in equity markets there is a volatility smirk which results in higher IV for lower strike price options because of crashophobia and leverage related factors but I can't wrap my head around ...
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Exercise on arbitrage-free process
Consider the following problem, from Bjork's Arbitrage Theory in Continuous Time:
Consider the standard Black-Scholes model. Derive the arbitrage free price process for the $T$-claim $\mathcal{X}$ ...
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Option pricing with negative short-term interest rates
In countries with negative short-term risk-free interest rates, do you just use a negative "r" in the Black-Scholes formula, or do adjustments need to be made?
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Black-Scholes-Merton formula and option pricing
If the distribution is skewed to the right,Black-Scholes overprices out-of-the-money puts and in-the-money calls. It underprices in-the-money puts and out-of-the-money calls.
How?
Stock price log-...
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1answer
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How is $\phi_t = \Delta_t$ in the martingale approach to pricing under Black-Scholes?
In the martingale approach to derivative pricing, we show that there exists a replicating strategy $(\phi_t, \psi_t)$ which mimics the derivative payoff. My textbook then goes on to state that it is ...
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1answer
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When is a numerical solution the only way to obtain a solution to BS?
I am only now reading into Mathematical Finance, I understand the derivation of the BS equation with vanilla European options. On the next page of my book it starts to delve into obtaining exact ...
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1answer
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Proof that we can price any derivative as the discounted value of its expected return under the risk neutral measure
I am reading a paper which tries to convey the intuition behind the Black-Scholes pricing formula. In that paper, the author states the following two things without proof, and I would like to know why ...
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How to explain the asymmetry of vanilla Volga?
I've plotted the charts of Volga of Vanilla Call/Put using finite difference method, and found they are the same, and an asymmetrical shape of observed for both. Any intuitive way to explain the ...
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OTC equity option under foreign currency CSA
What adjustment do I need to make to the Black-Scholes equation when the CSA of an OTC equity option is in a different currency than the underlying in order to get the correct price?
For instance, ...
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0answers
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Dimension reduction for worst of basket on $min(S_1, S_2)$
Suppose we want to price an exotic equity which is a function of $min(S_1, S_2)$. To do this, I'm trying to compute an implied volatility surface for $min(S_1, S_2)$ and then price the option using ...
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Classic dynamic delta-gamma hedging in Python
I am trying to run a delta-gamma hedge for a Black-Scholes model in Python.The Euler disceretizatioin of the paths is the simplest possible. I wrote the code below but the PnL looks undesirable and ...
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1answer
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Black Sholes option pricing with all but Delta [closed]
I'm trying to setup a little option pricing model in excel. I have all the information for the inputs (interest rate, IVs for different deltas, time to expiry, strike price, underlying price) but what ...
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1answer
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Hedging an option on a non-traded asset in BS world
I have given the following task given.
Suppose you are in a Black-Scholes World where you have the standard assets
$$ dS_t = \mu S_t dt + \sigma S_t dW_t $$
$$ dB_t = r B_t dt $$
and now you also ...
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2answers
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Do we need to assume underlying returns are normal in BSM model, given Central Limit Theorem?
I am trying to get a better understanding of Central Limit Theorem and how it can be used in life and in finance. From what I have read, the BSM model assumes the underlying asset's simple returns ...
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1answer
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How can the BS riskless hedge break down when volatility changes, if a random walk can produce any price history?
Supposedly, a Black-Scholes riskless hedge will break down if the volatility is non-constant. However, a random walk with any sigma could produce any price history with some non-zero probability. If ...
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Can we use Black-Scholes to price path dependent options?
I know that we can use the Black-Scholes framework to price vanilla products like a European call or put, where the payoff only depends on the share price at maturity.
But can we use it to price path ...
