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Option pricing

To use the BSOP model we need to identify the five key input variables.

‘P ’ is the PV of the future
a
‘P ’ for a call option is the cash flows from the project
e
capital investment required. (excluding any initial
‘P ’ for a put option is the investment) i.e. value of the
e
salvage value on project being undertaken (call)

abandonment option, or value of the cash
flows foregone (put)

‘t’ is easy to 5 key variables ‘s’ can be
pick up if the measured using
project involves
a single typical industry
sector volatility
investment
‘r’ is still the risk-free rate,

(but there is an argument
that says a higher rate
should be used to reflect
risk of the project)

Illustrations and further practice

Now try Illustration 6 and TYU 7 from Chapter 8

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