Options are a type of derivative instrument because their price is linked to the price of the underlying security, such as stock. Buying an options contract grants the right, but not the obligation, to buy or sell an underlying asset at a set price (known as a strike) on/before a certain date. The main reason for the popularity of options is because they hedge away exposure to an asset's price moving in an undesirable way.
A European call/put option gives us the right (but again, no obligation) to buy/sell a certain asset on a certain expiry date (commonly denoted as T).
Some popular methods of options' valuation:
- Using analytic formulas
- Binomial tree approach
- Finite differences
- Monte Carlo simulations
European options are an exception in the sense that there exist an analytical formula for their valuation, which is not the...
