Derivatives & Options
Price options with Black-Scholes, understand put-call parity, and use forwards and futures for hedging. Derivatives seem complex but most exam problems test a handful of core relationships. Mastering payoff diagrams and put-call parity covers the majority of what you will see on finance exams.
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Study Tips
- ✓Draw payoff diagrams for every strategy
- ✓Put-call parity is a quick sanity check
- ✓Know the five Black-Scholes inputs
- ✓Understand Greeks conceptually even if not computing them
Common Mistakes to Avoid
Confusing the payoff at expiration with the profit (which subtracts the premium paid). Also applying European option formulas to American options without adjustment, and forgetting that American calls on non-dividend stocks are never exercised early.
Derivatives & Options FAQs
Common questions about derivatives & options
C + PV(K) = P + S. It links call price, put price, strike present value, and stock price for European options. If the equation does not hold, there is an arbitrage opportunity.
Time value. There is always a chance the option moves into the money before expiration. The longer the time to expiration and the higher the volatility, the more time value an option has.
Stock price (S), strike price (K), time to expiration (T), risk-free rate (r), and volatility of the underlying (sigma). All five are needed, and the model assumes European-style options with no dividends in its basic form.
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