Page 161 - AFM Integrated Workbook STUDENT S18-J19

Option pricing

2.4 The underlying assumptions for the BSOP model

The BSOP formula introduced above should only be used for European
options. It relies on a number of assumptions which may not hold true in
practice:

 perfect markets

 there is a market for the underlying asset

 there exists a constant risk-free interest rate and constant volatility

 the returns on the underlying asset follow a normal distribution

2.5 The Greeks – delta

It is important to understand how sensitive the option value is to changes in the
BSOP model input factors. ‘The Greeks’ measure this sensitivity.

The most important of the Greeks is delta (given by N(d 1) in the BSOP formula).

Delta measures the change in option value that would result from a
$1 change in the value of the underlying asset (e.g. share).

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