Two-state option pricing model

Similar financial terms

Up-and-Out Option
An option that ceases to exist when the price of the underlying asset increases to a set level.

Up-and-In Option
An option that comes into existence when the price of the underlying asset increases to a set level.

Synthetic Option
A synthetic is an option created by trading the underlying asset.

Swing Option
A swing option are found in the energy market. Its value depends on the consumption of energy, which must be between a minimum and maximum level. There is usually a limit on the number of times the option holder can change the rate at which the energy is consumed.

Static options replication
A static options replication is a procedure for hedging a portfolio that involves finding another portfolio of approximately equal value on some boundrary.

Spread option
AN option where the payoff depends on the difference between two market variables.

Exotic option
A non-standardized option

Real option
An option involving real (as opposed to financial) assets where. Real assets include land. plant, and machinery.

Option class
All options of the same type (call or put) on a particular stock.

Abandonment option
The option of terminating an investment earlier than originally planned.

Yield curve option-pricing models
Models that can incorporate different volatility assumptions along the yield curve, such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing models.

Wild card option
The right of the seller of a Treasury Bond futures contract to give notice of intent to deliver at or before 8:00 p.m. Chicago time after the closing of the exchange (3:15 p.m. Chicago time) when the futures settlement price has been fixed.

American option
An option that may be exercised at any time up to and including the expiration date.

American-style option
An option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American style.

Virtual currency option
An option contract introduced by the PHLX in 1994 that is settled in US$ rather than in the underlying currency. These options are also called 3-Ds (dollar denominated delivery).

Timing option
For a Treasury Bond or note futures contract, the seller's choice of when in the delivery month to deliver.

Time value of an option
The portion of an option's premium that is based on the amount of time remaining until the expiration date of the option contract, and that the underlying components that determine the value of the option may change during that time. Time value is generally equal to the difference between the premium and the intrinsic value.

Tax-timing option
The option to sell an asset and claim a loss for tax purposes or not to sell the asset and defer the capital gains tax.

Tax deferral option
The feature of the U.S. Internal Revenue Code that the capital gains tax on an asset is payable only when the gain is realized by selling the asset.

Stock option
An option in which the underlying is the common stock of a corporation.

Stock index option
An option in which the underlying is a common stock index.

Split-fee option
An option on an option. The buyer generally executes the split fee with first an initial fee, with a window period at the end of which upon payment of a second fee the original terms of the option may be extended to a later predetermined final notification date.

Quality option
Also called the swap option, the seller's choice of deliverables in Treasury Bond and Treasury note futures contract.

Put option
This security gives investors the right to sell (or put) fixed number of shares at a fixed price within a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain price by a certain time in order to protect, or hedge, an existing investment.

Put an option
To exercise a put option.

Postponement option
The option of postponing a project without eliminating the possibility of undertaking it.

Path dependent option
An option whose value depends on the sequence of prices of the underlying asset rather than just the final price of the asset.

Out-of-the-money option
A call option is out-of-the-money if the strike price is greater than the market price of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of the underlying security.

Options on physicals
Interest rate options written on fixed-income securities, as opposed to those written on interest rate futures contracts.

Options contract multiple
A constant, set at $100, which when multiplied by the cash index value gives the dollar value of the stock index underlying an option. That is, dollar value of the underlying stock index = cash index value x $100 (the options contract multiple).

Options contract
A contract that, in exchange for the option price, gives the option buyer the right, but not the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a specified time period, or on a specified date (expiration date).

Option-adjusted spread (OAS)
(a) The spread over an issuer's spot rate curve, developed as a measure of the yield spread that can be used to convert dollar differences between theoretical value and market price. (b) The cost of the implied call embedded in a MBS, defined as additional basis-yield spread. When added to the base yield spread of an MBS without an operative call produces the option-adjusted spread.

Option writer
An option writer is the option seller.

Option seller
Also called the option writer , the party who grants a right to trade a security at a given price in the future.

Option price
Also called the option premium, the price paid by the buyer of the options contract for the right to buy or sell a security at a specified price in the future.

Option premium
The option price.

Option not to deliver
In the mortgage pipeline, an additional hedge placed in tandem with the forward or substitute sale.

Option elasticity
The percentage increase in an option's value given a 1% change in the value of the underlying security.

Option
Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be worth more than the price set by the option (the strike price), plus the price they paid for the option itself. Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of a class of securities called derivatives, so named beca ...

Naked option strategies
An unhedged strategy making exclusive use of one of the following: Long call strategy (buying call options ), short call strategy (selling or writing call options), Long put strategy (buying put options ), and short put strategy (selling or writing put options). By themselves, these positions are called naked strategies because they do not involve an offsetting or risk-reducing position in another option or the underlying security.

Multi-option financing facility
A syndicated confirmed credit line with attached options.

Margin requirement (Options)
The amount of cash an uncovered (naked) option writer is required to deposit and maintain to cover his daily position valuation and reasonably foreseeable intra-day price changes.

Lookback option
An option that allows the buyer to choose as the option strike price any price of the underlying asset that has occurred during the life of the option. If a call, the buyer will choose the minimal price, whereas if a put, the buyer will choose the maximum price. This option will always be in the money.

Liquid yield option note (LYON)
Zero-coupon, callable, putable, convertible bond invented by Merrill Lynch & Co.

Knock-in option
An option that begins to function as a normal option ("knocks in") once a certain price level is reached before expiration. Might not knock in at all.

Knock-out option
An option with a built in mechanism to expire worthless should a specified price level be exceeded.

Bargain-purchase-price option
Gives the lessee the option to purchase the asset at a price below fair market value when the lease expires.

Barrier options
Contracts with trigger points that, when crossed, automatically generate buying or selling of other options. These are very exotic options.

Basket options
Packages that involve the exchange of more than two currencies against a base currency at expiration. The basket option buyer purchases the right, but not the obligation, to receive designated currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of exchange. A basket option is generally used by multinational corporations with multicurrency cash flows since it is generally cheaper to buy an option on a basket of currencies than to buy ...

Binomial option pricing model
An option pricing model in which the underlying asset can take on only two possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Call an option
To exercise a call option.

Call option
An option contract that gives its holder the right (but not the obligation) to purchase a specified number of shares of the underlying stock at the given strike price, on or before the expiration date of the contract.

Chicago Board Options Exchange (CBOE)
A securities exchange created in the early 1970s for the public trading of standardized option contracts.

Compound option
Option on an option.

Covered or hedge option strategies
Strategies that involve a position in an option as well as a position in the underlying stock, designed so that one position will help offset any unfavorable price movement in the other, including covered call writing and protective put buying.

Currency option
An option to buy or sell a foreign currency.

Dealer options
Over-the-counter options, such as those offered by government and mortgage-backed securities dealers.

Ho-Lee Option Model
An arbitrage free model which uses an estimated spot curve to evaluate embedded options in credit or fixed income securities.

London Option
A generic term sometimes used to describe options on physical commodities or on futures contracts traded abroad (typified by options on London commodity markets). These options, which often had nothing whatsoever to do with legitimate foreign markets, gained notoriety--prior to their ban in the United States in 1978--because of the sales practices and fraud allegations associated with the American dealers who sold them.

Seller's Option
The right of a seller to select, within the limits prescribed by a contract, the quality of the commodity delivered and the time and place of delivery.

Transferable Option
A contract which permits a position in the option market to be offset by a transaction on the opposite side of the market in the same contract.

Administrative pricing rules
IRS rules used to allocate income on export sales to a foreign sales corporation.

Underpricing
Issue of securities at a discount to their market value.

Regulatory pricing risk
Risk that arises when regulators restrict the premium rates that insurance companies can charge.

Pricing efficiency
Also called external efficiency, a market characteristic where prices at all times fully reflect all available information that is relevant to the valuation of securities.

Black-Scholes model
The Black-Scholes model is the most commonly used formula when evaluating European call and put options. The equation was first published by economists Myron Scholes and the late Fisher Black in 1973. Later, Scholes and Robert Merton earned the Nobel Prize in Economics (1997) for the work done on the model and for its general contribution to the understanding of valuation of financial assets.

The formula makes some key assumptions that must be fulfilled in order to give the right answer ...

Two-factor model
Black's zero-beta version of the capital asset pricing model.

Stochastic models
Liability-matching models that assume that the liability payments and the asset cash flows are uncertain.

Simple linear trend model
An extrapolative statistical model that asserts that earnings have a base level and grow at a constant amount each period.

Single index model
A model of stock returns that decomposes influences on returns into a systematic factor, as measured by the return on the broad market index, and firm specific factors.

Single factor model
A model of security returns that acknowledges only one common factor.

Pie model of capital structure
A model of the debt/equity ratio of the firms, graphically depicted in slices of a pie that represent the value of the firm in the capital markets.

Modeling
The process of creating a depiction of reality, such as a graph, picture, or mathematical representation.

Market model
This relationship is sometimes called the single-index model. The market model says that the return on a security depends on the return on the market portfolio and the extent of the security's responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against returns on the market portfolio.

Constant-growth model
Also called the Gordon-Shapiro model, an application of the dividend discount model which assumes (a) a fixed growth rate for future dividends and (b) a single discount rate.

Extrapolative statistical models
Statistical models that apply a formula to historical data and project results for a future period. Such models include the simple linear trend model, the simple exponential model, and the simple autoregressive model.

Harrod-Domar growth model
An economic model which maintains that the growth rate of GDP depends upon the level of savings and the capital output ratio.

Jensen Model
Jensen's model proposes another risk adjusted performance measure. This measure was developed by Michael C. Jensen and is sometimes referred to as the Differential Return Method. This measure involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. Required re ...