Simple Heuristics on the Black-Scholes Option Pricing Model

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Simple Heuristics on the Black-Scholes Option
Pricing Model

• Rossitsa Yalamova
• University of Lethbridge

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Objective and Goal

• Develop passion for creative solution and
  intuition of the variables relationships in the
  model
• Develop instructional design and educational
  technology for the foundations of derivative
  valuation and the basic principles of risk
  management and hedging.

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Problem Solving

• Algorithms do not necessarily lead to
  comprehension but promise a solution, while
  heuristics are understood but do not always
  guarantee solutions.
• PDE for the solution of the BSOPM

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The Black-Scholes model
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Concrete example technique

• Option at the money (SK) risk free rate is 0

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Option at the money (SK) R0

• T1 s0.8

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(SK) risk free rate positive

• Risk free rate moves the area to the right by
  and increases the value as K is
  discounted

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Adding positive instantaneous return (SgtK)

• The moves to the right by

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Option out-of-the-money r0

• The area moves to the left by

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Option out-of-the-money rgt0
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Implied volatility
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Volatility Smiles
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Portfolio Insurance

• Protective put
• S56 P2.38, K50
• Short position in the stock and long in the risk
  free asset
• Ws SN(d1)/(SP)