Options and Volatility, step 2 of 5
OP9 Risk-neutral valuation
Session timeline
Briefing
Trading30 min
Debrief
The case
A stock, a bond, and a call and a put at 25. The option prices are set by trading.
Objective
Finish with as much wealth as possible. Assessed on final wealth.
What it shows
- Risk-neutral valuation: pricing an option as a discounted expected payoff.
- Two options on one stock priced against the stock and the bond.
- A class pricing the same claim and disagreeing.
Watch out for
- A call and a put that sit apart from the price the stock and bond imply.
- Using the stock's probability of going up as if it were the risk-neutral one.
- Forgetting to discount: interest is 1%, small but enough to separate two prices.
Who takes part
- Trader — every student. Trades STOCK, BOND, C25, a call, and P25, a put, both at a strike of 25.
Class size
Ten to forty students in one role. The options have no other price source, so the class sets them.
Concepts
- Option pricing
Roles
Trader
You trade a stock, STOCK, a bond, BOND, a call, C25, and a put, P25.
- The two options share a strike of 25.
- Assessed on final wealth.
Instruments
| Ticker | Name | Market | Students can |
|---|---|---|---|
| STOCK | The stock | Continuous trading | Trade it |
| BOND | Zero-coupon bond | Continuous trading | Trade it |
| C25 | Call at 25 | Continuous trading | Trade it |
| P25 | Put at 25 | Continuous trading | Trade it |
In the tracks
- Step 2 of 5 in Options and VolatilityA stock and a bond, with a call and a put to price across two states.